Deflation on the Brain 08-12-2010

Cusick’s Corner
With deflation on the brain, the market still seems to be in risk-off mode. Major markets, bond yields, the Euro and Aussie currencies are all in the red. Some analysts see this market correlating to the markets in late summer of 2008. However, there is one big difference -- there is more cash on the sidelines now than there was in 2008. Short-term, risk adverse trades are the focus at this stage and short-term bearish trades seem to be the position of choice. The market has pulled back dramatically over the past few sessions, but still far away from S&P 500 support levels of 1050, where market players will challenge July 6th lows. See you After Hours.

Stock market averages opened sharply lower on disappointing economic and earnings news, but have since battled off the worse levels and are sporting only modest losses midday Thursday. After a 265-point skid Wednesday, the Dow Jones Industrial Average opened lower again Thursday morning after the Labor Department reported that filings for jobless benefits rose by 2,000 to 484,000 last week. Economists were expecting to see a decline of about 17,000. Stock index futures were already in the red prior to the data following losses in overseas markets and after Cisco Systems (CSCO) shares fell on disappointing earnings guidance. The networking giant, and bellwether for technology spending, is down 9.4 percent to 21.50. Meanwhile, the Dow Jones Industrial Average is off 38 points, but 72 points off session lows. The tech-heavy NASDAQ lost 12. Options action reflects the cautious underlying tone, with about 3.7 million calls and 3.65 million puts traded through 11:00 ET.

Bullish
Macy’s (M) shares rallied nearly 6 percent on earnings yesterday, but are down 26 cents to $20.26 midday Thursday. An interesting spread traded in the name in morning action after one strategist bought 10,000 November 21 calls at $1.47 per contract and sold 10,000 November 24 calls at 56 cents. This spread, at a 91-cent net debit (plus commissions) represents a bullish play on the retailer. It makes its best profits if shares rally beyond $24 by the November expiration.

General Mills (GIS) shares came under pressure on August 5th after Russia banned grain exports due to drought, which sent wheat prices running higher. The concern was that, higher wheat prices would hurt the food producer’s profit margins. However, shares are up 55 cents to $34.36 after Reuters published a report noting that General Mills and Kellogg both hedge their exposure to commodities prices. Options action is picking up as well, with about 10,000 calls and 1,750 puts traded in GIS through midday.

Bearish
The biggest options trades so far today are in the Financial Select Sector Fund (XLF). XLF shares, which represent ownership interest in all of the financial names in the S&P 500, are off 6 cents to $14.15. It appears that a bearish spread was initiated when an investor sold 66,000 September 15 calls at 18 cents to buy 66,000 September 14 – 13 put spreads at 31 cents. This three-way spread has traded 82,000X and if the strategist is called on the September 15s, they will be asked to sell 8.2 million shares at $15 each. This strategist might think shares are going to fall further and wants to capitalize on the bearish 14 – 13 put spread. The sale of the calls helps to pay for the spread.

Technology Select Sector Financial (XLK) is seeing interest as well. This exchange-traded fund holds all of the information technology names in the S&P 500 and is down 29 cents to $21.38 after one of its biggest components, Cisco, tumbled on earnings news. Meanwhile, in the options market, one large spread traded, in which an investor sold 10,000 August 22 puts at 74 cents and bought 15,000 September 21 puts at 58 cents. The play is probably a roll, or closing out in-the-money puts to buy out-of-the-money puts that have an additional month until expiration. August options expire at the end of next week.

Unusual Volume Movers
Cisco Systems (CSCO) options volume is running 4X the usual, with 399,000 contracts traded and call volume accounting for about 58 percent of the activity.

Juniper Networks (JNPR) options activity is running 3X the usual, with 40,000 contracts traded and put volume representing 85 percent of the volume.
Lennar (LEN) options volume is running 5X the usual, with 33,000 traded and call volume representing 89 percent of the activity.

Unusual volume is also being seen in Macy’s (M), NetApp (NTAP), and Virgin Media (VMED).

Implied Volatility Movers
Xilinx (XLNX) implied volatility is higher after BMO Capital Markets cut the chip equipment maker to Under Perform from Market Perform. Shares are down $1.46 to $25.39 and 29,000 options traded so far, including 12,000 calls and 17,000 puts. Meanwhile, implied volatility in XLNX options is up about 10 percent to 34.