Balancing Election Results with Trading Ideas 11-01-2010

Cusick' Corner
The highly anticipated mid-term elections are tomorrow, so how can a trader or investor strategize the potential outcomes? If the election plays out as pundits anticipate, GOP takes the House and the Democrats maintain the Senate, we could see a short-term gridlock bounce and then a consolidation until sideline money can figure potential entry points into the market. That is a macro level perspective, but how might you look at the individual races as they pertain to the market and potential reaction, maybe a little longer term? With the amount of turnover expected, due to retirement or loss by incumbents, there is going to be leadership shifts in key committees. For example, Chris Dodd is retiring, that means there will be a new Finance Committee Chairman. If the Dems' keep control of the Senate, Tim Johnson of South Dakota is anticipated to be the successor to Dodd. Since Johnson's state has heavy exposure to credit card operations, aka JOBS, it is plausible that he and the committee could be more favorable to these companies, i.e. start looking at credit card companies that may have operations in the state of the senator that heads a key committee. This is how we can balance the election results with potential investment/trading ideas. See you Midday and get out and vote.

Major averages finished mixed following a relatively volatile trading session Monday. Economic news was in focus early after a report released before the bell showed personal incomes falling .1 percent and spending up .2 percent in September. Economists were looking for gains of .2 percent in incomes and .4 percent in spending. Yet, with help from strength in overseas and commodities markets, the Dow Jones Industrial Average opened higher and moved to its best levels of the day after the Institute of Supply Management [ISM] index of manufacturing activity was released. ISM showed improvement to 56.9 in October, up from 54.4 in September and much better than the 54.0 that economists had expected. A separate report showed construction spending up .5 percent in September and also better than the .7 percent decline that economists had expected. Major averages hit a high on the data, drifted lower into midday and then a round of aggressive selling surfaced in the final hour. At its lows, the Dow Jones Industrial Average was down 56 points and off 182 points from session highs. However, things had stabilized by the closing bell and the Dow settled the day up 7 points. The NASDAQ lost 2.6.

Bullish Flow
Steelmaker Nucor (NUE) lost 2 cents to $38.02 on the session and options volume rose to 3X the average daily, with about 29,000 calls and 3,230 puts traded in the name. A good chunk of the volume was due to a ratio spread, in which an investor apparently sold 17,304 November 40 calls at 51 cents and bought half as many (8,652) December 40 calls at $1.02. This looks like an ongoing position adjustment in NUE. On October 1, the October – November 40 call spread traded 25,000X. At that time, it appears the investor was rolling out of October and into November. So, this strategist might be adjusting a bullish position at the first of every month and two or three weeks before the options expiration. They probably want to maintain exposure to the name, but not see the position lose too much value due to time decay. Shorter-term options experience time decay at a faster rate than longer-term options.

Bullish options action was also seen in Southwest Energy (SWN), Avanir Pharmaceuticals (AVNR), and Discover Financial Services (DFS).

Bearish Flow
Big Lots (BIG) has seen two days of bearish trading. Options action picked up in the November 30 and 32.5 puts Friday. A total of 5,590 puts and 235 puts traded on the retailer. Today, shares lost 47 cents to $30.90 and options volume hit 6X the average daily after 4,144 calls and 3,048 puts traded on the session. The top trade was 783 December 30 put – December 35 call bearish risk-reversals at 72 cents on ISE. That is, according to ISEE sentiment data, this investor was buying December 30 puts and selling December 35 calls to open a new bearish position. The risk-reversal traded more than 1,500X on the day. There is no recent news on the ticker. Shares are in the midst of a four-day 8.4 percent skid and the bearish traders Friday and Monday might be taking positions on concerns about the downside momentum building in BIG shares.

Bearish flow also picked up in AMAG Pharmaceuticals (AMAG), Exco Resources (XCO), and American Movil (AMX).

Index Trading
Trading in the index pits is slow, even as significant event risk looms. In addition to the mid-term elections tomorrow and a Fed rating meeting Wednesday, monthly jobs data have market moving potential Friday. Yet there's little hedging activity going on. 453,000 puts and 331,000 calls traded across the S&P 500 Index (.SPX) and other cash indexes Monday, which is 72 percent the normal activity, according to Trade Alert data. However, while volume is light, the CBOE Volatility Index (.VIX) has been moving. VIX is in the midst of a six-day 16.2 percent run higher. The volatility index finished up .63 to 21.83. Like last week, VIX is moving higher despite little movement in the SPX, which finished up 1.12 to 1,184.38. A rising VIX in a period of very low actual volatility could be warning for investors to brace for increasing volatility in the weeks ahead.

ETF Trading
While volume in the index market is light, there have been signs of hedging activity in the exchange-traded funds. For example, Powershares QQQ (QQQQ), which holds all of the NASDAQ 100 names, added 4 cents to $52.22 and 318,000 puts (138,000 calls) traded in the Qs. January 48 and 50 puts were the most actives. More than 58,000 traded in each (116K total) and the volume included a lot of spread trading. For example, in morning action, 5000 Jan 50 puts traded at the $1.29 ask and 5000 Jan 48 puts mid-market at 82 cents. The action has the signs of a bearish spread, at a 47-cent debit, and one that offers a max pay-off if shares fall to $48 or less by the January expiration. A portfolio manager looking to hedge risk through yearend might have initiated the trades. The NASDAQ 100 is an index of the top 100 non-financial companies listed on the NASDAQ.