It Takes Two to Contango 05-18-2010

Cusick’s Corner
The market closed well off the initial pace of the open. While the EU is the driving force behind this market pressure, I do not want to lose sight that this is expiration week. We have already seen what the impact has been so far with June Crude expiring today. Why would something like that be important? Well, for one thing this seems to be a potential signal of a price correction, coupled with a larger fund shifting out of long positions. It’s also a potential indication of contango. This is when the front month or “spot” is trading at a discount to future months. To put possible implications of contango into context, that means an ETF like USO, which tracks oil by having the front month future in the fund, has to roll their expiring position. They would be selling something that is worth less than what they are buying, thus costing money and potentially negatively impacting the price of the ETF. This is a prime example of knowing when assets like futures and options are expiring because other assets could be impacted as well.

The stock market averages were again under pressure, as concerns about the European Debt Crisis and the falling euro thwarted any rally attempts Tuesday. The stage was set for morning gains on Wall Street after European equity markets marched modestly higher and the euro recaptured the 1.24 handle. However, the early stock market advance had faltered by midday, as investors once again took the lead from the falling European currency. By Tuesday afternoon, the euro had fallen back below 1.23 against the dollar and the ongoing weakness rekindled the ongoing concerns about Europe’s debt problems, along with the possible implications for banks that hold the debt and the broader global economy. In the US, Walmart (WMT) rose 1.9 percent and was the only gainer in the Dow Jones Industrial Average after reporting better-than-expected earnings. At the end of the day, the Dow was down 115 points and the NASDAQ had lost 38.

Bullish Flow
Vodafone (VOD), the Berkshire, England telecommunications company, finished down 53 cents to $19.54 and options volume picked up Tuesday. About 13,000 calls and 2,940 puts traded on the day. January calls at the 22.5 line saw the most action. The top trade of the day was 502 contracts at 80 cents on the International Securities Exchange [ISE], where sentiment data indicate an investor was buying the calls to open a new position. 10,856 contracts traded total, compared to 3,050 contracts of open interest. So, it appears that some players were buying-to-open new positions in calls on Vodaphone, perhaps looking for VOD to recapture some of the 17.5 percent drop that the stock has suffered over the past month.

Verisign (VRSN), Dr Pepper Snapple (DPS), and Intermune (ITMN) also had bullish order flow.

Bearish Flow
Yingli Energy (YGE), a Baoding, China-based maker of semiconductors for the solar industry, lost 4 cents to $9.24 Tuesday. Options action included 4,300 puts and 1,650 calls. June 7.5 puts saw the most action. 2,525 traded and, with 72 percent trading at the asking price and existing open interest of 623 contracts, it appears that buyers were taking defensive positions in the name. June 10 and Sep 9 puts were being bought as well. Implied volatility is elevated at 84 percent, up about 1 point Tuesday, and the bearish trading comes ahead of earnings, on May 24 (before market).

Bearish flow also picked up in Xerox (XRX), Capital One (COF), and Seagate Technology (STX).

Index Trading
Trading remains brisk in the index market, as portfolio managers turn to S&P 500 Index (SPX) puts and other products to hedge themselves from the recent increase in market volatility. More than 1 million puts traded across the SPX and other cash indexes Tuesday. S&P 500 June 1125, August 1100, and May 1,100 puts were among the most actives. The index closed down 16.14 points to 1,120.80. Meanwhile, the CBOE Volatility Index (.VIX), which tracks the expected volatility priced into SPX options, rose 2.71 points to 33.55.

ETF Trading
IShares Long-Term Bond Fund (TLT) is benefiting from the recent turmoil. Shares added $1.45 to $95.98 Tuesday after weakness on Wall Street along with tame inflation data (PPI at -.1 percent in April) triggered a rally in Treasury bonds Tuesday. In the options market, noteworthy action was seen in January 100 calls. It included a block of 7,780 contracts at $2.80, which appeared to be a buyer opening a new position. More than 8,500 traded through midday. These buyers were apparently taking positions in anticipation of additional strength in Treasuries and for the gains in TLT to continue through yearend. Shares of the exchange-traded fund are up almost 10 percent since early April.