Think Defense 08-13-2010

Cusick’s Corner
These end-of-the-week markets have been in quite a quandary. This pullback has been on light volume and today’s was one of the lowest of the year. Most recent data tells us that at home -- deflation prospects are increasing and unemployment is still a challenge, while abroad -- the Euro currency is pulling back on fears that the economic turnaround is much slower than expected. Over the weekend, start to think about defense which is sometimes the best offence, meaning consider defensive sectors like Bonds, Gold and Utilities to help build some risk aversion and yield into your portfolio. For those die hard bulls, since volatility popped 4 points this week in the overall market and it’s been on the move in quite a few sectors, consider either potentially buying bull call spreads or selling naked puts (remember that when you sell a naked put you are taking on the possible position of owning the stock). It is now time to go do my radio show and actually enjoy some nice weather this weekend. Enjoy and see you Midday.

The major averages finished with modest losses on a light volume, slow trading session Friday. After a three-day 324-point drop, the Dow Jones Industrial Average wavered again in early trading after monthly Retail Sales data showed an increase of .4 percent in July, which was slightly less than the .5 percent that economists had expected. Separate data showed the Consumer Price Index [CPI] up .3 percent, and .1 percent more than expected. A third report, released shortly after the opening bell, the University of Michigan index of consumer sentiment was released and showed improvement to 69.6 in August from 67.8 the month before, but less than the 70.0 that economists had expected. In the end the data didn’t matter much and the major averages were flat into midday. Then in the final hour, a modest round of selling pressure surfaced and the industrial average finished with a 17-point loss. The NASDAQ lost 16.8.

Bullish Flow
Dynegy (DYN) rallied on news private equity firm Blackstone is making a move to buy the power company for $4.7 billion, or about $4.5 per share in cash. Shares rallied $1.75 to $4.53 on the news and options volume surged to 250X the average daily, after about 94,000 call options and 5,420 puts traded in the name. More than 77,000 December 5 call options changed hands. The strike price of the December 5 call options is 50 cents above the proposed buyout price. So, some investors were likely selling premium on the view that shares won’t move beyond $5 through the December expiration and those calls will expire worthless. However, shares also finished 3 cents above the takeover price which seems to reflect expectations that a higher bidder might emerge.

Bullish flow was also detected in Wendy’s (WEN), Pacific Sun (PSUN), and Taiwan Semiconductor (TSM).

Bearish Flow
ITT Education Services (ESI) was among several for profit education names seeing selling pressure Friday. Shares lost $4.97 to $64.33 on concerns new regulations will force for-profit education companies to cut programs and tuitions, while accepting fewer students. The Obama administration has been pushing for such changes as many students have graduated faced with heavy debt loads, but few job prospects. The new rules are designed to limit the amount of loans made available. So, the education sector is under pressure as the details of new rules unfold. ESI is one of them and, as shares tumbled to new 52-week lows Friday, 11,000 puts and 4,980 calls traded in the name.

Bearish flow also picked up in Apollo Group (APOL), Anally Mortgage (NLY), and Verisign (VRSN).

Index Trading
Overall options volume was light Friday, with about 308,000 calls and 450,000 puts traded across the cash indexes like the S&P 500, which is about 86 percent the average daily. It was a relatively slow session. The S&P 500 traded in a 7-point range and finished down 4.4 points. The lack of volatility might have eased some of the recent concern about the market outlook and sidelined some players in the index market. Many “pros” are on vacation, which helps explain the light volume as well. The pattern might change early next week, however, as volatility has been on the rise in recent days and investors get manufacturing and NAHB housing data Monday, then Housing Starts, PPI, and Industrial Production numbers Tuesday. The CBOE Volatility Index (.VIX) added .51 to 26.24 Friday. VIX rallied more than 20 percent on the week.

ETF Trading
The Financial Select Sector Fund (XLF) has seen two days of bearish three-way spread trading in its September options. Shares, which represent ownership interest in all of the financial names in the S&P 500, finished down 4 cents to $14.07 and it appears that a bearish spread was initiated Friday when an investor sold 16,000 September 15 calls at 19 cents to help pay for 16,000 September 14 – 13 put spreads at 26 cents. This three-way spread represents a bearish bet, because it makes its best profits if shares fall to $13 or less by the September expiration. The three-way spread traded more than 80000X Thursday and another nearly 100,000 over the past two days.