Earnings Miss 09-22-2010

Cusick's Corner
The grind continued into the After Hours. Many market watchers are reviewing Adobe's earnings and whether their earnings miss becomes a pattern, thereby potentially forcing other companies to issue warnings. From an options perspective, players are taking advantage of volatility and time premium in longer-term options. Whether buying OTM butterflies, selling OTM puts or ATM ratio call spreads, some larger strategists are positioning long by using bullish spreads to mitigate both premium and volatility risk. The most notable trade today of this nature was in SWN (see Bullish Flow). See you Midday.

Major averages finished lower in a day of slow and cautious trading Wednesday. With no economic news to guide the action, the focus was on the day's story stocks. Adobe (ADBE) suffered a 19 percent drop on disappointing earnings news. EBAY lost 1.6 percent after issuing an uninspiring third quarter revenue outlook. Meanwhile, Microsoft (MSFT) shares were off 2.2 percent and the biggest losers in the Dow Jones Industrial Average, as investors expressed disappointment with the software maker's plans to raise its dividend. However, a sharp rally in Alcoa (AA) helped limit the Dow's losses, as shares jumped 4.5 percent on expectations for strengthening aluminum prices. At the end of the day, the industrial average had traded in a 97-point range and was off 22 points. The NASDAQ lost 14.8.

Bullish Flow
Southwest Energy (SWN) saw interesting trading activity Wednesday. Shares of the Houston, Texas oil and gas company added 11 cents to $32.20 and options volume was 7X the average daily. Most of the increased activity was the result of one massive spread. In this trade, the investor bought 10,000 SWN January 32 calls at $2.80, sold 15,000 January 36 calls at $1.13, and sold 15,000 January 29 puts at $1.30. In essence, the strategist sold the 15,000 January 29 puts at $1.30, to buy the January 32 – 36 (2X3) call ratio spread, 10000X at $1.67. It's a very bullish play, as it offers a max pay-off if shares move to $36 by the January expiration. This investor is also a possible buyer of SWN at $29 per share, because if it trades below that level through the January expiration, the January 29 puts, which were sold, will be assigned.

Bullish flow was also detected in Sears Holding (SHLD), Brocade (BRCD), and Netflix (NFLX).

Bearish Flow
Computer Associates (CA) saw a noticeable uptick in put activity Wednesday. Shares finished up 3 cents to $20.65 and options volume hit 7.5X the average daily, with about 16,800 puts and 4,100 calls traded on the software maker. The focus was on February 19 and 20 puts, with 3875 and 9366 contracts traded, respectively. In addition of today's puts, 91 percent traded at the asking price, according to data from web site Whatstrading.com; which suggests that put buyers were dominating the action. There was no news to explain the heightened activity. It might be a play on earnings that are due mid-October.

Bearish flow also picked up in Fastenal (FAST), Western Union (WU), and Juniper Networks (JNPR).

Index Trading
The CBOE Volatility Index (.VIX) saw interesting trading activity Wednesday. VIX, which tracks expected volatility priced into S&P 500 Index (.SPX) options, finished the day up .16 to 22.51 and substantial call spreads surfaced in morning action. To be specific, one investor bought 23,000 VIX Oct 24 - 26 call spreads at 60 cents plus 8000 Oct 25 - 27.5 call spreads at 57.5 cents. The same investor also sold 23,000 Jan 25 - 27.5 call spreads at $1.325 plus 23,000 Feb 25 - 27.5 call spreads at $1.325. The action seems to be rolling of call spreads from October to January and February. If so, this strategist is closing buying back short call spreads in October, but extending a bet that volatility will stay below the mid-20s through January and February. A total of 237,000 calls and 141,000 puts traded on a busy day for the VIX Wednesday.

ETF Trading
Energy Select Sector Fund (XLE) is an exchange-traded fund that holds all of the energy-related names from the S&P 500. Shares lost 40 cents to $54.44 today after crude oil slipped 25 cents to $74.72 on bearish inventory data. Meanwhile, in the options market, an interesting spread in the XLE Wednesday was a January 50 – 47 (1X2) put ratio spread, opened at a 48-cent credit, 11,500X. That is, it looks like the investor bought 11,500 of the January 50 puts at $1.66 while selling 23,000 January 47 puts at $1.07, which is a bearish bet because it has a max pay-off if XLE falls to $47 by the January expiration. There's also risk of assignment if shares fall below $47 because the spread consists of two short puts for every one long put. The spread trader here might also be a willing buyer of XLE at $47.