Fed Watch 08-08-2011

Cusick Corner
All eyes will be on the Fed tomorrow, their language will be scrutinized and traders will be on edge. I got a question about what may be a signal that the equities may be potentially firming up and potentially bounce - look at commodities like Copper, JJC, Lumber, LBU11, and Cotton, BAL/CTV11. If you see these commodities make higher lows and firm up, may be signaling that a bounce could be in the works. But the reality is that the markets need to get some sort of confirmation that there is a glimmer of growth in the economy. Also one note, the sector of equities that would benefit greatly from higher interest rates (and they are coming) are the Financials, XLF/KRE, so start looking at the best of breed in this space. See you After Hours.

The bloodletting continued on Wall Street Monday. After losing 7.1 percent last week, the S&P 500 Index (.SPX) opened sharply lower after Standard & Poor's downgraded US debt Friday after market hours. Stocks fell sharply across Asia and Europe before the opening bell sounded on the NYSE. The selling then intensified mid-morning after S&P also announced that it was downgrading Fannie and Freddie debt. There was a modest rebound attempt through midday, but sellers resurfaced in afternoon action. The concern is not just with debt, but that S&Ps move also reflects a downgrade to the global economy. Deleveraging by hedge funds and margin calls are probably exacerbating market volatility as well. Meanwhile, crude oil is also under pressure and lost $6.29 to $80.59 a barrel. Fear and flight-to-safety are obvious, as gold hit new records and the yield on the ten-year Treasury fell to just 2.35 percent. The S&P lost 6.7 percent, the Dow gave up 5.6 percent, and the NASDAQ tumbled 6.9 percent.

Bullish
Despite the high levels of volatility and the substantial market losses suffered in August, some individual names continue to see bullish order flow - as investors take positions in options rather than shares of specific beaten-down companies. Dendreon (DNDN), for example, lost $2.19 to $10.37 today and has tumbled 71 percent since earnings were reported last Wednesday. Yet, sentiment in the Seattle, WA biotech seemed decidedly bullish today as about 28,000 calls and 6,200 puts traded in the name. The top trades of the day were part of a spread, in which the strategist apparently bought 2,900 Sep 12 calls at $1.18 and sold 2,900 Sep 18 calls at 23 cents. They paid a 95-cent debit of the spread and are probably using the position to play a bounce in the stock. That is, instead of buying shares, they're locking in the right to buy or "call" the stock at $12 through the September expiration. They could have it called away at $18 (the higher strike) if shares rally beyond that level through September expiration.

Bullish trading was also seen in Weatherford (WFT), Virgin Media (VMED), and Human Genome Sciences (HGSI).

Bearish
Bank of America (BAC) saw a surge of options activity today. Shares sank $1.66 to $6.51 in volatile trading after an analyst suggested the bank might need to raise capital. The bank was out with a statement today saying that it has more than enough capital. Yet, given the volatility in the financial markets lately, BAC shares were aggressively sold today and options volume hit more than 3X the average daily for the bank. An impressive 662,000 calls and 969,000 puts traded in BofA Monday. August 10 puts, which are now 34.9 percent in-the-money, were the most actives. 74,530 traded. Jan13 12.5 calls, Jan 5 puts, and Jan13 20 calls were very busy as well. Players are jockeying for position in the options in anticipation of the next move in the bank. Consequently, implied volatility in BAC options surged 69 percent to 145.

Bearish flow also surfaced in Research In Motion (RIMM), Quicksilver (KWK), and Masco (MAS).

Index Trading
CBOE Volatility Index (.VIX) added 16 points to close at session highs of 48. The volatility index made a run higher early and then the rally gained additional momentum in the late-afternoon. The market's "fear gauge" is now at its best levels since May 21, 2010, when the index briefly touched 48.2. VIX has rallied 200 percent in the past month! The surge in the volatility index reflects the bearish sentiment and high anxiety levels that investors now face. Index option volume has been heavy as well. 1.25 million puts and 643,000 calls traded on the S&P 500 Index today, which is more than double the average daily volume for the SPX trading pit. CBOE Volatility Index tracks the expected volatility priced into S&P 500 Index options and tends to move higher when there is aggressive buying of puts to hedge stock portfolios.

ETF Action
SPDR Oil Exploration and Production Fund (XOP) saw a day of heavy trading. The ETF, which holds shares of major oil companies like Chevron and Exxon, tumbled $5.99 to $47.12 after crude oil prices plunged $6.29 to $80.59 a barrel. Meanwhile, options volume in the fund was 6X the average daily. 180,000 puts and 12,000 calls traded in the XOP today. The top trades were part of a ratio spread, after an investor sold 35,000 September 55 puts and bought 52,000 September 50 puts on XOP. This spread likely rolls a position down in strikes after the big move lower in shares. That is, they're closing out a position in the 55s to open a new larger position in the 50s. XOP is down 24.3 percent month-to-date and both contracts are now in-the-money.