Short Covering Rally 05-21-2010

Cusick's Corner
There was an impressive rally into the close, much of it due to short covering for the weekend which then set off a big short imbalance. The VIX had quite a day range today of 38.95 – 48.20, closing nearer the day’s lows at 40.10. This choppy, volatile trade coupled with Expiration Friday created huge stock volume -- over 2.3 billion shares traded today on the NYSE. Financials were the leading advancing sector today after suffering several down days in a row. The Financial Select Sector ETF (XLF) was up over 3.5%. Take the weekend to prepare for what looks to be another potentially choppy trading week. Existing Homes Sales will kick off next week’s list of important economic releases. After this exhausting week, we will all need a little break. Have a good weekend.

Stocks finished higher thanks to a late-day burst in the final hour. The Dow Jones Industrial Average sank nearly 150 points early, as Asian and European markets suffered another day of losses. In the US, there was no economic data to guide the action and some of the focus was on Washington after the Senate passed its version of the Financial Reform bill. Shares of many banks and brokers slipped in morning trading on concerns about the implications of the financial overhaul. However, heavy short-covering mid-morning along with a rebound in European markets helped send the Dow back into positive territory and up 129 points into midday. Then, the Dow gave up the gains, fell back into negative territory, before rallying again into the close. The industrial average added 125 points on the session and finished near its best levels of the day. The CBOE Volatility Index (.VIX) hit a morning high of 48.20, midday low of 38.95, and lost 5.69 to 40.10 on the day. Trading was very active due to the options expiration, about 11.5 million calls and 14.8 million puts traded.

Bullish Flow
Brazilian steel and iron maker Vale S.A. (VALE) saw a day of brisk trading. After a one-month 26.2 percent slide, shares rallied $1.72 to $25.70 Friday. Meanwhile, 62,000 calls and 76,000 puts traded in the name. The top trades of the day included a bullish June 20 – 30 risk-reversal, where an investor apparently bought 8,800 June 30 calls at 22 cents per contract and sold 8,800 June 20 puts at 32 cents. This trade is a short-term play. June options expire four weeks from today. June 30 puts saw interest as well, with some institutional traders selling large blocks at $5.15 and $5.90 per contract. These premium sellers are probably liquidating positions after the stock’s recent slide.

Meritage Homes (MTH), Sotheby’s (BID), and Teradyne (TER) also had bullish order flow.

Bearish Flow
Yingli Energy (YGE), the Chinese alternate energy company, added 34 cents to $9.57 Friday. Meanwhile, options action remains cautious and implied volatility is elevated ahead of the company’s earnings report, due out Monday before the bell. Shares have suffered a grueling 24.2 percent month-to-date slide ahead of the news. Implied volatility is up to 95, from 57 in late April. In options action Friday, the flow reflected the bearish mood. The top trade was an apparent seller of June 11 calls at 55 cents each -- 2074 contracts traded. Meanwhile, June 9 puts traded 1,348X, with about 95 percent of the trades hitting at the ask price, indicating put buyers ahead of the results.

Bearish flow also picked up in Knight Capital (NITE), Lincare (LNCR), and Tyco Electronics (TEL).

Index Trading
Trading in European Style S&P 100 Index (.XEO) saw more options action than usual. The index differs from the S&P 100 Index (.OEX) because the options contracts settle European style. The OEX settles American style. What’s the difference? Most index products settle European style and therefore options can only be exercised at expiration. OEX is one of the few that doesn’t and exercise/assignment can happen any time prior to expiration. XEO options have become a bit more popular in recent years. Friday, for example, about 50,000 puts and 12,000 calls traded on the index – or about 6X the recent average daily volume.

ETF Trading
Direxion Daily Financial Bear 3X Bear Fund (FAZ) saw a day of brisk trading. Shares, which are designed to move (300 percent) the inverse to the financial sector, finished the day down $1.77 to $15.17 following a strong rebound in the group Friday. However, shares are up 10.7 percent on the week and players were aggressively selling calls into the May expiration. 148,000 calls and 46,000 puts traded on the exchange-traded fund. Of the 194,000 contracts traded, 102,000, or 52.6 percent, were May contracts. June 16, 17, and 18 calls were actively traded as well.