Identifying Lepidopterans 05-20-2011

Cusick's Corner
This market just feels like volatility is ready to pounce. While that statement is not very scientific, there are strategic approaches that can take advantage of that volatility. For example, take a look at butterfly spreads which are traditionally done with either all calls or all puts. Traditional butterflies involve three strike prices that are created from the combination of both a long spread and a short spread. The expiration months and increments between strike prices for all options should be the same (equidistant). For example, stock XYZ is at $40.10 and I think that volatility could creep in next few weeks and I have a bias to the upside. So I decide to trade a long OTM butterfly, meaning buy one 41 strike call for $1.50 & sell two 43 strike calls for $1.00 & buy one 45 strike call for $.60 for a total net debit of $.10 which is $10 in real dollar terms. Your maximum loss potential is limited to the premium paid (debit) for the spread. At expiration this will occur if the underlying stock price is above $45 or below $41 (known as the wings which in this case are the two long strikes) and this trade is profitable at expiration if the underlying stock is trading between $41.11 and $44.9. Build some of these examples into the Trade Calculator this weekend. See you Midday.

Stock market averages slipped on poor earnings from the retail sector and worries about the European Debt Crisis. With an absence of economic data to guide early trading on options expiration Friday, some of the focus was fixated on the sliding euro. The European currency lost .7 percent to the US dollar on worries about the European Debt Crisis after Fitch cut Greece's credit rating. Meanwhile, in the US, disappointing earnings news from Aeropostale (ARO) and Gap Stores (GPS) weighed on the retail sector. The SPDR Retail Trust (XRT) lost 1.7 percent. A rebound in some of the commodities seemed to lend the market some support through midday. Crude oil gained $1.25 to $100.18 per barrel and gold added $21.9 to $1,514.30 an ounce. However, another round of selling pressure surfaced late in the day. At the closing bell, the Dow Jones Industrial Average had lost 93 points and the tech-heavy NASDAQ gave up 20.

Bullish
Goldcorp (GG) hit a morning low of $47.62, but erased early losses after gold made a turnaround Friday. The yellow hit a low of $1,486.40 in early trading, but then rallied to $1,514 an ounce. The nearly 2 percent midday run in gold seemed to spark some interest in some of the miners, like GG. Shares finished the day up 30 cents to $48.66. Meanwhile, options volume totaled 21,000 calls and 8,680 puts. Expiring May 49 calls were the most actives, with more than 4,200 traded. However, the top trade of the day was in October calls and included a spread. In this play, the investor apparently bought 2,000 October 50 calls at $2.97 and sold 2,000 October 55 calls at $1.50, paying $1.47 for the spread and possibly looking for shares to rally beyond $55 through the October expiration.

Bullish trading was also seen in Supervalu (SVU), KB Homes (KBH), and Brocade (BRCD).

Bearish
Aeropostale (ARO) saw a day of very heavy trading after the company posted earnings that fell short of expectations. Shares of the teen apparel retailer sank more than $3 to $18.30 and touched new 52-week lows Friday. Options volume rose to 9.5X the average daily, with 33,000 calls and 19,000 puts traded in ARO today. The top trade of the day was a combination, in which the investor bought 11,000 July 19 puts and sold 11,000 July 23 calls. They paid a net debit of $2.32 for this bearish risk-reversal and were likely closing, at a big loss, a position opened a few days earlier at 35 cents. It was not a total all bad, however, as the original trade was tied to 545,000 shares. While they took a hit on the risk-reversal, the probably banked a tidy profit on the short stock position.

Bearish flow also surfaced in American Eagle (AEO), Officemax (OMX), and KB Homes (KBH).

Index Trading
CBOE Volatility Index (.VIX) bounced back to life today. The US equities market saw several days of relatively quiet trading this week and VIX had suffered a three-day 14.9 percent slide prior to today's trading session. However, with help from volatility in euro and a round of disappointing earnings results from the retail sector, the S&P 500 Index (.SPX) lost 10.33 points to 1,333.27 on the day. VIX, which tracks the expected volatility priced into SPX options, jumped 1.91 points to 17.43. Meanwhile, the most actively traded index contract today was VIX June 22.5 calls. 44,516 traded. Another 35,752 June 25 calls traded. Some investors might be bracing for additional volatility in the weeks ahead and taking positions in these short-term out-of-the-money VIX call options.

ETF Action
SPDR Retail Trust (XRT) gave up 91 cents to $52.41 following disappointing profit reports from Gap Stores and Aeropostale, which finished the day down 17.5 percent and 14.3 percent, respectively. Meanwhile, options volume in XRT jumped to 4X the average daily. 87,000 puts and 10,000 calls traded in the ETF today. The top trade of the day was an apparent ratio spread, in which the investor bought 9,000 June 51 puts and sold 18,000 June 47 puts. The position is a bearish play, as it makes its best profits if shares fall to $47 through the June expiration, which equates to a 10.3 percent drop over the next four weeks. Another noteworthy trade was a block of 16,500 December 44 puts that traded at $1.36 on ISE and was an opening customer buyer, according to ISEE data. It's noteworthy because, with shares at $52.41, these puts are 16 percent out-of-the-money.