Straddle Earnings 04-06-2011

Cusick's Corner
The market is now gearing up for earnings and a lot of readers are asking how can we strategize for these events. Strategically you can plan for these events based on your interpretation of volatility, and in options that is measured by Implied Volatility. This is confusing so I take a different approach and I lay out a scenario where I price a volatility strategy, like straddles, to help me determine the potential move the options market is anticipating in an underlying going into an event. For example, if you were to look at the front month at-the-money straddle for AA, the straddle is pricing in the potential for a $1 range up or down. Through additional research and forecasting, if you believe that the underlying has the ability to move that much in the next 9 days, this could be a viable strategy. See you Midday.

Stock market averages finished higher with help from Cisco Systems (CSCO) Wednesday. Cisco was the best gainer in the Dow Jones Industrial Average and also helped the NASDAQ. Shares gained 4.9 percent after CEO John Chambers suggested Tuesday that major changes in the operations could be in the works. Meanwhile, the action in the commodities markets continues, as gold hit yet another record high and crude oil made a run north of $109 per barrel. There was no economic data Wednesday and weekly jobless claims, due Thursday morning, are the only numbers of real significance for the rest of the week. Investors are really waiting for earnings. Alcoa (AA) unofficially kicks off the first quarter reporting season Monday afternoon. AA and Cisco were among 20 Dow stocks to finish in the black today. Ten moved lower and the industrial average added 33 points. The tech-heavy NASDAQ added 8.6.

Bullish
Citigroup (C) call options were heavily traded today. Shares gained 2.7 percent to $4.59 and settled at best levels in weeks after Bloomberg reported that the financial services giant is looking to expand its commodities investment group by a third over the next two years. The motivation is increasing demand for gold, copper and other commodities. Shares were up and options volume in Citi included 648,000 calls/441,000 puts. April 4.5 calls, which are now nine cents in-the-money and expire at the end of next week, were the most actives. More than 140,000 contracts traded. May and January 5 calls saw heavy trading as well. The January 4 and 5s were the most active puts. Attention soon turns to Citi's earnings on April 18. A reverse 10-for-one stock split in Citigroup shares happens on May 6.

Bullish trading was also seen in JC Penney (JCP), American Axle (AXL), and CVS Caremark (CVS).

Bearish
Meritor (MTOR), which recently changed its ticker symbol and its name from ArvinMeritor, finished the day up 9 cents to $17.00 per share. Options volume in the name included 7,640 puts and 300 calls. May 19 puts were the most actives. The top trade was a 200-lot at the $2.55 asking price. At the end of the day, 7,312 contracts traded. Since open interest is just 126 contracts, it looks like some investors were opening new positions in these in-the-money put options. Shares sank 15.2 percent after the company lowered its second earnings guidance on 3/31 and the bearish order flow might be a play on the disappointing profit news.

Bearish flow also surfaced in Gap Stores (GPS), Zimmer Holdings (ZMH), and Skywork Solutions (SWKS).

Index Trading
The CBOE Volatility Index (.VIX) continued its slide today. The market's "fear gauge" lost .35 to 16.90 and closed at its lowest levels since February 18, which was the trading session just before unrest in Libya sent crude oil prices rallying and stocks sharply lower. VIX rallied 22.2 percent on February 22 and then continued to rally through March 16, when the index hit a multi-high of 31.28. It has since given back the gains and there are very few signs that investors are bracing for higher volatility in the near future. As evidence, not only is VIX falling, but there's very little interest in S&P 500 Index (SPX) puts this week. Only 245,000 puts traded in the SPX pits today, which is about half the recent average daily volume. Light volume in the index market and low VIX are signs that not many institutional investors are buying premium to protect stock portfolios today.

ETF Action
The iShares Industrials Fund (XLI) has seen interesting options action in recent days. Shares added 4 cents to $37.93 today and the top index options trade in the exchange-traded fund was a May 37 - 34 put spread bought at 47 cents, 63000X. That is, the investor bought 63,000 May 37 puts at 65 cents and sold 63,000 May 34 puts at 18 cents. The same spread traded at 49 cents, 15000X Tuesday. An institutional investor looking to hedge exposure to the sector might be initiating the spreads. XLI holds all of the industrial companies from the S&P 500 and includes names like General Electric (GE), United Technologies (UTX) and Caterpillar (CAT). The spread offers a max payout if shares fall to $34 or less through the May expiration, or about 10.4percent over 44 days.