Traders on Watch for Potential Short-Term Pullback 12-30-2010

Cusick's Corner
The market has been in a choppy range and in spite of good economic news, no one seems to be in the mood to expand current positions until we get into the New Year. While the fundamentals demand that you are either long or wrong, this over exuberance of positive sentiment placed traders on watch for a potential pullback, especially if short-term profiteers (like those who participated in the recent one-month 7% run up) get nervous and want to bank some of those profits. Watch a break of 1250 on the S&P 500, this might shake up the short-term trade but remember the long-term sentiment is bullish. See you tomorrow for the final trading day of 2010.

Economic news was back in focus Thursday morning after data released before the opening bell showed weekly jobless claims falling by 34,000 to 388,000 in the period ended December 25. Economists were looking for a decline of only 6,000. Separate data released later showed the Chicago PMI gauge of regional manufacturing activity up to 68.6 in December, which was up from 62.5 last month and much stronger than the 61.5 that economists had forecast. Pending Home Sales showed an increase of 3.5 percent in November, which was also much better than the 3 percent drop that economists were expecting. Overall action remained uninspired despite the stronger-than-expected economic numbers. End-of-year position squaring is a factor. A $1.50 drop in crude oil and an $8 loss in gold seemed to weigh on some of the commodity-related names. Markets finished broadly lower across Europe as well. At the end of the day, however, not much volatility was stirred. The Dow Jones Industrial Average traded in a 42-point range and lost 15 points. The tech-heavy NASDAQ gave up 4.

Bullish Flow
Verigy (VRGY), a Singapore-based chipmaker, finished up 21 cents to $13.25 today, but remains well below a recent takeover bid of $15 per share offered by Advantest. The company sweetened its bid to $15 from $12.5 one week ago. Yet, there seems to be some uncertainty about the deal because Verigy shares are trading $1.75 below the proposed price. One options strategist seems to be bracing for good news for VRGY shareholders, however, and initiated a substantial bullish spread in the stock Thursday. In this strategy, they apparently bought 5,000 of the January 13 calls at 85 cents and sold 5,000 January 14 calls at 25 cents. This spread, at a net debit of 60 cents, is a bullish. It offers its max payout if shares move to $14 or more by the January expiration.

Bullish order flow was also seen in BJ's Wholesale (BJ), St. Jude Medical (STJ), and Dean Foods (DF).

Bearish Flow
Two of the top stock options trades in a relatively slow day of trading were in Citigroup (C). Shares of the financial services giant lost one penny on the session, to $4.76, and one strategist apparently sold 10,000 January 5 calls at 7 cents to buy 10,000 January 4.5 puts at 6 cents. This bearish risk-reversal might be a closing trade or, if opening, an outright bearish bet. On the other hand, a shareholder might have initiated the position to “collar” or protect a position in shares. 10,000 collars would hedge 1 million shares. By selling the Jan 5 calls, they're also willing to sell the stock at $5 through the January 2011 expiration.

Bearish flow also picked up in MDC Holdings (MDC), Knight Transportation (KNX), and NetApp (NTAP).

Index Trading
There's not much to report from the index pits lately, as many institutional players have closed the books on 2010 and are away for the holidays. Volume is light, with 227,000 calls and 345,000 puts traded across the S&P 500 Index (.SPX), CBOE Volatility Index (.VIX) and other cash indexes. In addition, there hasn't been much volatility. The S&P 500 Index traded in another narrow 5-point range and lost 1.9 points on the day. Meanwhile, the CBOE Volatility Index (.VIX) finished up .27 to 17.55. The actual volatility, or statistical volatility, of the S&P 500 is now only 9.2 percent. Therefore, since VIX tracks the expected volatility priced into S&P 500 options, it is forward-looking and suggests that players in the options market expect (are pricing in) the possibility for a substantial increase in volatility heading into 2011.

ETF Trading
Market Vectors Rare Earth Minerals ETF (REMX) is seeing increasing activity. Shares of the exchange-traded fund finished the day up 64 cents to $24.50 and have been rallying this week after China announced plans to cut quotas on rare earth materials on Tuesday. REMX, which holds a number of companies involved in the industry from around the globe, is now up 14.4 percent on the week. Players in the options market are beginning to take notice as well. Volume in the ETF jumped to 13X the normal Thursday. 4,065 REMX calls and 500 REMX puts traded on the session.