Points to Consider When Selling Options 05-04-2011

Cusick's Corner
I wanted to discuss selling options in this afternoon's Corner. Generally speaking, option selling is a more aggressive strategy compared to option buying. The option seller has an obligation to buy or sell the security which can expose a trader to greater risk. Therefore, it is critical to always calculate your risk on every trade. When selling options, you are trying to take advantage of time decay. Therefore, consider selling front month options since near-the-money options decay much faster than options with longer expirations. You also want to sell options with the most extrinsic value. Here are some general guidelines for selling options: sell 45 days or less, sell out-of-the-money, sell at-the-money if directional, look for options with tighter spreads, open interest above 100, make sure you are using precise money management guidelines, use stops and pick an exit, use trailing stops if you don't want to exit the trade otherwise use a 10% risk model and 50% safety net for unexpected disasters (volatile stocks). See you Midday.

Stock market averages finished with losses on disappointing economic data Wednesday. ADP reported this morning that the US economy added 179,000 private sector jobs last month. Economists were predicted an increase of 200,000. The news comes two days before the Labor Department releases its key monthly payroll report. Separate data released later Wednesday showed the ISM Services Index falling to 52.8 in April, down from 57.3 and well below economist estimates of 57.4. Meanwhile, commodities are under pressure again today. Crude oil lost $2.23 to $108.82 per barrel and gold gave up $22.5 to $1,517.9 an ounce. Within the Dow Jones Industrial Average, Chevron Texaco (CVX) and Exxon (XOM) were among twenty-two Dow losers. Some of the cyclical names, DuPont (DD), Caterpillar (CAT), and Alcoa (AA), are among the biggest percentage decliners in the industrial average. At the end of the day, the Dow had given up 84 points, but finished up 51 points from session lows. The tech-heavy NASDAQ lost 13.4.

Bullish
Semiconductor equipment maker Xilinx (XLNX) saw interesting options action today. Shares bucked the bearish trend and added 27 cents to $35.15. Meanwhile, options volume hit 4X the average daily. 20,000 calls and 2,250 puts traded in XLNX today. Most of the action was in smaller sizes. The top trade was a 235-lot of January 40 calls at the $1.39 asking price. May 37 calls, which are 5.3 percent out-of-the-money and expire in two and half weeks, were the most actives. 5,130 traded. May 36, June 36 and June 37 calls were busy as well. It's not clear what was driving the action. There was no news on the ticker. For whatever reason, it seems like short-term speculators were active in XLNX today.

Bullish trading was also seen in STEC, Gap Stores (GPS), and Conagra (CAG).

Bearish
Intel (INTC) shares touched a new 52-week high today and finished the day up 45 cents to $23.50. The stock has been in rally mode since earnings were reported on April 19. Shares of the world's largest chipmaker are up 18.3 percent since that time. Meanwhile, trading in Intel options was very heavy today. Volume was 243,000 calls and 179,000 puts. The top trade surfaced late in the day after an investor apparently bought 10,000 June 24 puts at $1.06 and sold 10,000 June 23 puts at 56 cents. That is, they bought the June 23 - 34 put spread at 50 cents, 10000X, and might be looking for the stock to drift back below $23 through the June options expiration.

Bearish flow also surfaced in Dicks Sporting Goods (DKS), Evergreen Solar (ESLR), and Murphy Oil (MUR).

Index Trading
The CBOE Volatility Index (.VIX) is on a four-day winning streak. The volatility index gained .38 to 17.08 and is now up almost 20 percent from the 52-week lows set last week. VIX has been moving higher in recent days ahead of key jobs data due out Friday. Yet, while VIX is moving higher, the overall volume in the index market remains relatively light. There's no sign of aggressive portfolio hedging. 392,000 calls and 559,000 puts traded across the S&P 500 Index (.SPX), VIX and other cash indexes, which is about 90 percent of the recent average daily volume, according to Trade Alert data. The most active index options were VIX June 16, 17 and 18 puts.

ETF Action
iShares Silver Fund (SLV) saw another day of heavy trading Wednesday. Shares lost 5.7 percent to $38.27 and are now down 18.4 percent on the week. Silver is in the midst of a dramatic pullback after a surge of nearly 80 percent since late-January. The volatility in the metal is driving a lot of action in options on the silver fund. 717,000 calls and 837,000 puts traded in the SLV today. The top trade of the day was a spread, in which the investor sold 24,000 May 38 puts at $1.81 and bought 24,000 May 36 puts at $1.05. They collected 76 cents on the spread and might be closing a position, and/or betting that SLV will hold above $38 through the May expiration, which is in 16 days.