Bonds May Be Signaling... 05-28-2010

Cusick's Corner
The market has pulled back and the volume and sentiment is lower. With this sentiment change, volatility popping in the last week and the appetite for risk, bonds may be signaling a short term support. The After Hours should be light now that all the data and traders are fleeing out of the office and enjoying the long weekend. See you After Hours.

Stocks are broadly lower following big gains Thursday and a round of mixed economic news Friday. Although stock index futures moved higher early, the Dow Jones Industrial Average slipped at the open after rallying 285 points yesterday and after data on April Personal Incomes and Spending fell short of expectations. While incomes rose .4 percent and in-line with estimates, spending was flat. Economists were looking for a .3 percent increase in spending. Later, the ISM Index for May showed a decline to 59.7 from 63.8 the month before. Economists were looking for the gauge of manufacturing activity to fall to 60. The University of Michigan Sentiment Index was a bright spot, rising to 73.6 in May, which was up from 73.3 earlier in the month and better than the 73.2 reading economists had expected. Yet, after big gains tallied Thursday, the tone of trading has turned more cautious ahead of the three-day Memorial Day weekend. The Dow Jones Industrial Average is down 67 points. Options volume is slowing, with about 2.1 million calls and 2.1 million puts traded at 10:00 central time.

Bullish Flow
British Petroleum (BP) is down $2.13 to $43.25 after the oil giant said that its Top Kill operation to stem the flow of oil from the Gulf spill is showing some effectiveness, but that it will take 48 hours to determine whether or not it's a success. While shares are down, sentiment in the options market is mixed. 24,000 calls and 15,000 puts traded on BP so far. The top trade is a block of 4,500 January 46 calls at $3.20 per contract. It coincided with 450,000 shares at $43.30 and appears to be a covered call play. That is, the investor is buying shares and selling calls in a ratio of 1 call to 100 shares. The risk graph of the trade has a bullish profile, as the max profit is reached if BP moves to $46 or more by the January expiration.
The CBOE Volatility Index (.VIX) added .56 to 30.24 and action is being seen in the June 25 put - 35 call risk reversal Friday, which traded in large blocks in morning trading. For example, at 9:15 CT, 2000 June 25 puts traded on the bid for 80 cents while 2000 June 35 calls at the ask of $2.00. According to a contact on the CBOE, the trade was part of a bullish risk-reversal on the VIX, where the strategist paid a net debit of $1.20 to buy calls, sell puts. It might close an existing position or it might be a bet that volatility will remain high through the June expiration, which is 18 days for VIX puts and calls.

Bearish Flow
Large put butterfly spreads have been trading in the iShares Emerging Markets Fund (EEM) lately. The action continued Friday after the June 25 - 30 - 35 put fly traded at 29 cents, 75,000X. It appears that, like in previous days, the strategist is opening a substantial spread by selling 150,000 June 30 puts for the body of the fly and then hedging the bet by purchasing 75,000 of the June 25s and 35s. This spread has a bearish risk graph because the max profits are at $30.00, or $8.18 below the current market price of EEM, at the June options expiration.
ATP Oil and Gas (ATPG), a Houston-based oil and gas driller is seeing heavy trading. Shares are down 71 cents to $11.34 after the Obama administration halted deepwater drilling in the Gulf of Mexico. Meanwhile, in the options market, trading in ATPG is brisk. 23,000 puts and 3,330 calls traded so far. The action includes an apparent buyer of 7,600 January 5 puts at 65 cents, which appears to be a premium buyer taking a position on concerns about additional losses in ATPG during the months ahead.

Implied Volatility Movers
Transocean (RIG) shares are down and implied volatility remains elevated, as the driller holds a conference call Friday. The company says that US rig demand is intact despite the Gulf spill, but that some customers may take a "wait and see" approach. Shares are down nearly 4 percent to $57.37 and options volume includes 25,000 calls along with 12,000 puts. Implied volatility is up 6.5 percent to 65.

Unusual Volume
IShares Japan Fund (EWJ) options volume is running 3X the usual, with 31,000 contracts traded and call volume accounting for about 50 percent of the activity.
King Pharmaceuticals (KG) options activity is running 18X the usual, with 9,500 contracts traded and call volume representing 86 percent of the volume.
Cephalon (CEPH) options volume is running 3X the usual, with 8,660 traded and call volume representing 98 percent of the activity.
Unusual volume is also being seen in Medicines Companies (MDCO), Cubist Pharmaceuticals (CBST), and AgSeed (SEED).