Hot Option Plays: Bonds & Crude Up

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Cusick’s Corner 02-27-2012
The equities are in a holding pattern, i.e. consolidation, and bonds are testing the upside of a down trend. Equities did not give much of a “tell” into the After Hours but there was an interesting development in the bonds, TLT, where the downward trend line is being challenged with today’s close, TLT $118.54. If there is a break to the upside, this could be a signal for a potential breakout in the Treasuries which is not good for the equities. I also do not like the action in Crude, USO, this could be tough on growth and the markets, especially if Texas Tea keeps running to the upside and the equities and economy continue to just grind along. I am looking at this from a perspective of not becoming too complacent with the impressive trend that we have had in play for the last few months. Have a good night.

Stock market averages erased early losses and finished little changed Monday. The table was set for cautious trading on Wall Street after equity markets struggled overseas amid ongoing concerns about Europe’s most debt-ridden country – Greece. Moody’s reiterated cautious comments about the outlook for the deeply indebted country and warned that there is still a high chance of Greek debt default. However, after an early 100-point slide, the Dow Jones Industrial Average had battled back to positive territory at midday with help from a report on Pending Homes Sales, which was up 2 percent in January and 1 percent more than expected. News that Germany had approved the second Greek bailout seemed to bolster sentiment as well. Consequently, the Dow Jones Industrial Average was up more than 100 points off session lows at midday, but failed to build on the gains in afternoon action. At the end of the day, the Dow was down just 1 point. However, the tech-heavy NASDAQ added 2.4 points.

Bullish
Medco Health Solutions (NYSE:MHS) shares were up today on hopes the FTC will approve its merger with Express Scripts (NASDAQ:ESRX). Officials are still reviewing the deal, which values MHS at $28.80 per share in cash plus .81 per ESRX shares, or about $72 per share at current prices. MHS jumped to new 52-week highs on optimism for a favorable FTC decision and closed up $2.38 to $66.52 on share volume of 13.4 million, which is more than double the normal for the stock. 40,000 calls and 17,000 puts also traded in the name, which is 3X the daily average. The top trades of the day were part of a ratio spread, in which the strategist bought 3,000 April 67.5 calls on MHS and sold 6,000 April 75 calls on MHS. The 1X2 call ratio spread was bought for a $3 debit and will pay off if shares move towards $75 through the April expiration, which would probably happen in the deal is approved. If not, and shares hold below $67.5, the entire debit is at risk. There is also additional risk to the upside when holding call ratio spreads, because not all of the higher strike calls (which were sold) are covered by the lower strike calls that were bought.

Bullish trading was also seen in United Technologies (NYSE:UTX), TJX, and Texas Instruments (NYSE:TXN).

Bearish
Live Nation (NYSE:LYV), which came under pressure last week and lost 4.8 percent Friday after earnings were reported, dipped another 14 cents to $9.86 today on volume of 1.9 million shares, which is almost 2X the normal for the Beverly Hills, CA entertainment company. Meanwhile, 14,000 puts and 650 calls traded on the stock. April 7.5 puts, which are 23.9 percent out-of-the-money and expiring in 53 days, were the most actives. 5,253 traded. April 10, July 7.5, and July 5 puts on LYV were actively traded as well. It’s not clear what was driving the flow, but levels of implied volatility were up 13 percent to 51.5 on the day. High volume in downside puts along with increasing levels of implied volatility are sometimes a sign that investors are taking defensive positions in a name and/or bracing for a volatile move lower in the underlying shares.

Bearish trading was also seen in Pulte Group (NYSE:PHM), Ryland (NYSE:RYL), and Carnival Cruise (NYSE:CCL).

Index Trading
Like Friday, the S&P 500 Index (.SPX) didn’t move much Monday, but the CBOE Volatility Index (.VIX) scored another day of gains. After a modest 2.28 point move higher Friday, the S&P 500 gained 1.85 points to 1,367.59. Yet, VIX moved up .51 to 17.31 Friday and gained another .88 to 18.19. VIX typically moves lower when the S&P ticks higher. Over the past two days, VIX has been grinding higher and is 10.8 percent off the lows seen Friday morning. In addition, the actual or historical volatility [HV] of the S&P 500 over the past thirty days has fallen to just 8.4 percent! Since VIX tracks the expected or implied volatility priced into S&P 500 index options, a reading of 18.19 is very high (relative to actuals). It is almost 120 percent greater than the S&Ps 30-day historical volatility. This huge divergence between historical and implied volatility (VIX) in the S&P 500 is rare and is perhaps a sign that many players in the options market don’t think the very low levels of market volatility seen so far in 2012 are going to last. The options market is “implying” much higher levels of volatility for the future.

ETF Action
Bearish options action was highlighted in a couple of homebuilders – Pulte Group (NYSE:PHM) and Ryland Group (NYSE:RYL) – in today’s midday report. Similar trading activity surfaced in the April puts on the SPDR Homebuilder ETF (XHB) which is up more than 50 percent since September and added another 32 cents to $19.97 Monday. The top options trade in the ETF was an 8,300-contract block of April 20 puts traded for $1.16 and apparently was an opening buyer, according to data from one of the options exchanges. 10,300 traded on the day. XHB has been rallying and hit a multi-year high of $20.39 in early-February. However, it has failed to make a meaningful move beyond that level, which also coincides with its April 2010 high of $20 per share. Some investors might be taking out positions in downside April 20 puts on the fund to protect recent gains in the sector after the strong rally over the past five months. XHB is a fund that holds 34 different housing, homebuilding, and retailing names.

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