On Cusp of Deflationary Environment 07-01-2010

Cusick’s Corner
This is going to be a tough market to try to peg entries on either the long or short side. What is becoming abundantly clear is that all of us have to become more acquainted with how and potentially what to trade in a Deflationary environment. Yes, I have had colleagues (thanks Jack B.) who have been adamant that we are not on the cusp of inflation but deflation, on the scale that we have not seen since the 30’s. This means that gold and bonds continue to fall, stocks, commodities and housing will continue to be under siege. Once you are comfortable with this scenario, relationships like the plight of bond yields and how they correlate with the performance of the stock market will make more sense. See you After Hours.

Stocks fell on disappointing economic news Thursday, but the major averages strengthened late morning and are well off session lows midday. The table was set for morning losses on Wall Street after markets moved broadly lower across Europe on a Moody’s downgrade of Spain. In the US, the early focus was on jobless claims, which showed an increase of 13,000 last week and worse than the 1,000 drop that economists had predicted. The Dow Jones Industrial Average opened lower on the data and then came under additional pressure after separate reports released at 10:00am ET showed Pending Home Sales down 30 percent in May (vs. 10.5 percent consensus), the ISM Index at 56.2 in June (vs. estimates of 59), and construction spending down .2 percent in May (vs. -.9 percent consensus). The poor data helped send the Dow Jones Industrial Average down as much as 150 points. The NADSAQ lost 11.8. Meanwhile, options activity is very defensive, with about 5.2 calls and 6.5 million puts traded at 12:30 ET.

Bullish
BJ Wholesale (BJ) shares are rallying and options action is picking up after a regulatory filing shoed Green Equity Investors with a 9.5 percent stake in the company and included comments about the retailer possibly going private. Shares touched a new 52-week high and were recently up $5.44 to $42.45 on the news. Options volume is running more than 20X the recent average daily, with 3,900 calls and 4,200 puts traded so far. July 40 puts are the most actives, as some players sold the contract and are probably expecting shares to hold above $40 through the July expiration. July options expire in 15 days.

Norfolk Southern (NSC) shares are up 16 cents to $53.21 and options volume is 6X the average daily, driven by buyers of July calls. The July 55 is the most active. 7,444 traded and 64 percent traded at the Ask. Another 1,288 July 50 call options also changed hands. No news on the railroad company today and the overall action looks like speculative call buying in anticipation of a move higher in NSC shares over the next two weeks.

Bearish
The top options trades Thursday morning surfaced in the SPDR S&P 500 (SPY) exchange-traded fund. SPY holds the same stocks that comprise the S&P 500 and shares are down 60 cents to $102.62 today. In morning trading, one strategist paid 83 cents for the SPY July 98 – 94 put spread, 50000X. That is, they bought 50,000 of the 98s at $1.72 and sold 50,000 of the July 94s at 89 cents. This spread is probably a short-term hedge. July options expire in a little over two seeks and the best payoff from the position happens if shares settle below $94 at that time.

TRW Automotive (TRW) lost a dime to $27.47 and options volume is 8X the average daily, driven by buyer of August 25 – 20 put spreads at $1.25, 5000X in morning action. That is, the investor apparently bought 5,000 of the 25 puts at $1.65 and sold 5,000 of the 20 puts at 40 cents, which creates a bearish spread with a potential $3.75 payoff (excluding commissions), if shares fall to $20 or less by the August expiration.

Unusual Volume Movers
Select Sector Energy Fund (XLE) options volume is running 2.5X the usual, with 123,000 contracts traded and put volume accounting for about 83 percent of the activity.

Select Sector Tech Fund (XLK) options activity is running 4X the usual, with 71,000 contracts traded and call volume representing 74 percent of the volume.
Dendreon (DNDN) options volume is running 2.5X the usual, with 66,000 traded and call volume representing 51 percent of the activity.

Unusual volume is also being seen in EBAY, Royal Caribbean (RCL), and Mirant (MIR).

Implied Volatility Movers
The CBOE Volatility Index (.VIX) is falling despite another volatile day in the equities markets. The S&P 500 is down 5.4 points and the CBOE Volatility Index (.VIX), which tracks the expected volatility of S&P 500 index options, lost 1.47 to 33.07. The decline in the VIX comes after a three-day 6-point spike and might be technical in nature. VIX might also be falling due to expectations for quiet trading around the Fourth of July holiday.