Straddle Pricing Can Reveal Clues 05-05-2011

Cusick's Corner
So where's the market going? If I knew that I wouldn't be writing this piece. But I can look to the options marketplace for clues by pricing the at-the-money straddles, buying a call and a put at the same strike price in the same expiration month. Straddle traders are usually unsure of the exact direction a stock will move but they are expecting a significant price move. The straddle is priced by allowing enough edge for a liquidity provider to hedge their risk if in fact there is a significant move in the price of the stock in either direction. If you look at the Weekly straddle for SPY 133 strike, the market has priced in a 1.4% potential range up or down for the next 6 trading days, and 2.2% range up or down for the next 15 days. With the ETF under pressure and the support of 134, the market looks ready for some potential volatility. Knowing the potential range can help in strategy and strike price selection. See you Midday.

Stocks moved broadly lower in morning action on disappointing jobless claims data and then a sharp drop in commodities prices weighed on afternoon trading Thursday. Economic data was in focus early after the Labor Department said that weekly jobless claims increased by 43,000 to 474,000 in the period ended April 30. Economists expected a decline to 400,000. Separate data on Productivity was up 1.6 percent in the first quarter, which was better than the 1 percent that was expected. But the jobless claims numbers drove the market lower in early trading, as the disappointing reading comes one day before the Labor Department releases key monthly jobs numbers. Meanwhile, the action in the commodities markets was volatile today. Crude oil prices plunged more than $10 to $99.05 per barrel. Gold lost $44.80 to $1,470.50 an ounce and silver sank $5.03 to $34.30. Commodity prices are falling on concerns about the economy and amid a rally in the dollar. The Dollar Index gained 1.5 percent. The decline in commodity prices weighed heavily on Dow components Alcoa (AA), Exxon Mobile (XOM), and Chevron (CVX). Twenty-seven of the Dow thirty finished with losses and the industrial average gave up 140 points. The tech-heavy NASDAQ had battled back to positive territory at midday, but finished down 13.5 points.

Bullish
AMR options were heavily traded today. Shares gained 7.5 percent to $6.61 on positive April traffic numbers and after a plunge in crude oil prices perhaps eased come of the recent concern about the impact of rising jet fuel costs on the airline industry. Shares rallied and 62,000 calls/51,000 puts traded on the airliner. June 6 puts were the most actives. More than 40,000 changed hands. The top trade was a block of 8,800 that traded on the 73-cent bid and appears to be a put seller initiating a position. This investor might be looking for shares to hold above $6 through the June expiration. If not, they're probably a willing buyer at the price level. AMR May 7 and June 7 call options saw heavy trading as well.

Bullish trading was also seen in Republic Airways (RJET), KLA Tencor (KLAC) and Teradyne (TER).

Bearish
A number of the apparel retailers saw bearish trading after Aeropostale (ARO) lowered its first quarter earnings outlook today. American Eagle (AEO) was mentioned in the midday report. Urban Outfitters (URBN) is another. Shares lost 1.8 percent to $31.55. Options volume rose to 2.5X the average daily, after 9,300 puts and 1,600 calls traded in the name. May 32 puts, which are now 45 cents in-the-money, were the most actives. Nearly 5,000 traded and, with 72 percent trading at the ask, it looks like put buyers were initiating the trades. September 32, December 31 and December 32 puts saw interest as well. URBN is due to release its earnings on May 16, and before the expiration.

Bearish flow also surfaced in Advanced Auto Parts (AAP), Gold Resources (GORO), and Nexen (NXY).

Index Trading
The rally in the CBOE Volatility Index (.VIX) continued for a fifth day. The volatility index gained 1.12 to 18.20 and is now up almost 27.5 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 and amid a mini-crash in the commodities market. Volatility is higher across a number global financial markets this week and VIX is responding. Now, some investors seem to be getting a bit more defensive. 455,000 calls and 748,000 puts traded across the S&P 500 Index (.SPX), VIX and other cash indexes, which is about 113 percent of the recent average daily volume, according to Trade Alert data. Yet, while index put volume picked up noticeably, a lot of the action was in VIX puts and therefore not portfolio hedging. For a second day, VIX June 17 and 18 puts were among the most active index contracts.

ETF Action
Options volume surged in the commodity-related ETFS, as prices plummeted Thursday. iShares Silver Fund (SLV) lost 11.9 percent to $33.72 and options volume hit 3X the average daily. 2.2 million options contracts traded on the silver ETF! SPDR Gold ETF (GLD) lost 2.9 percent to $143.47 and options volume hit 2.5X the average daily. 746,000 options traded on the gold fund. US Oil Fund (USO) gave up 9.1 percent to $39.32 and options volume rose to 5X the average daily. 479,000 contracts traded in the oil fund. Finally, US Natural Gas ETF (UNG) lost 6.7 percent to $10.99 and options volume was 3X the typical levels. 127,000 options traded in UNG today.