Sustainability of Market Move 05-10-2010

Cusick’s Corner
The market pulled back from the highs into the afternoon, which does not come as unexpected. What is worrisome about this pullback is that there’s this sentiment of “hope” in the market. This starts to raise the question whether this move is sustainable. If you look at the currency markets, you may be potentially questioning this move. Specifically in the Euro today, the action started with a sharp uptick in the morning and a pullback into the afternoon. As I mentioned earlier today, spread trading could be deployed in this situation. For example, after this move if you are bearish and have a sentiment that implied volatility is high, consider buying OTM call calendar spreads -- sell front month Out-of-The-Money call and buy Out-of-The-Money call that has a later expiration date. See you Midday.

Stocks finished broadly higher, as investors applauded European bailout news. Stock index futures were limit up early Monday after EU leaders agreed to a $1 trillion bailout of European debt markets. Plus, the European Central Bank [ECB] said it would buy back eurozone national bonds and the US Federal Reserve agreed to provide billions in overseas loans. The efforts helped ease investor anxiety levels, bolster the euro, and rally European equity markets. Then, shares surged when the bell rang on Wall Street. Most of the gains held into the close and, at the end of the day, the Dow Jones Industrial Average had added 405 points. The NASDAQ rallied 109 points.

Bullish Flow
Transocean (RIG) shares came under pressure after the Wall Street Journal reported that the oil driller was the subject of significant numbers of investigations in 2008. Shares, which had already lost 26 percent since its Deepwater Horizon rig sank in the Gulf of Mexico, lost another $1.67 to $66.34. However, in the options market, sentiment seemed mixed with 118,000 calls and 50,000 puts traded on RIG. The top trades include 18,000 August 80 calls at $1.87 each and 18,000 August 90 calls at 52 cents. The action has all the hallmarks of a large debit spread and, if so, one that yields its best profits if the stock rallies back to $90 or more by the August expiration.

ING Group (ING), KB Homes (KBH), and Qualcomm (QCOM) also had bullish order flow.

Bearish Flow
Dell Computer (DELL) saw increasing options action Monday. Shares edged up 37 cents to $15.38. Meanwhile, about 33,000 puts and 5,460 calls traded on the computer maker. 14,100 May 14 puts traded and 78 percent of the volume hit at the offer. May 15 and May 16 puts were trading ask-side as well. Simply put, premium buyers seemed to be dominating the action and the timing is noteworthy because Dell is due to report earnings on May 20 which is two days before the May expiration.

Bearish flow also picked up in Moody’s (MCO), McGraw Hills (MHP), and Mylan Labs (MYL).

Index Trading
The CBOE Volatility Index (.VIX) plummeted Monday. VIX, which tracks the expected volatility priced into S&P 500 Index options, rallied an impressive 86 percent last week and closed at 40.95 Friday – its first closing above 40 since April 2009. However, as concerns eased about Europe’s debit crisis and the S&P 500 Index rallied 49 points, the volatility index tumbled 12.11 points to 28.82. The nearly 30 percent decline in VIX is rare. In fact, it’s the largest percentage drop in history of the volatility index. The big moves in the volatility index have stirred up increasing options action as well, with another 353,000 calls and 214,000 puts VIX puts traded Monday.

ETF Trading
The Select Sector Financials (XLF) added 84 cents to $15.93 after the financial names rallied around news of the EU bailout. XLF holds all of the financial-related names from the S&P 500 Index. Yet, while shares rallied 5.6 percent and implied volatility eased about 18 percent to 37.5, the overall tone of trading in the options market remained cautious. 375,000 puts and 166,000 calls traded on the ETF. Two of the top trades of the day appear to be part of a bearish spread, where an investor bought 36,000 May 15 puts at 20 cents while selling 36,000 May 14 puts at 7 cents each. If so, this spread (at a 13-cent net debit) offers an 87-cent payoff (excluding commissions) if shares fall to $14 or less by the May expiration (11 days).