Using Options for Insurance 11-12-2010

Cusick's Corner
Over the last four sessions the action has been “the trend is your friend.” But when you have an overwhelming sense of complacency, insurance should be looked at. This reminds me of the Mayhem commercials from Allstate, you have no insurance or cutthroat, and I guess it would make sense since you have had a clean record for the last 10 years. But lately there has been a rash of overnight fender-benders, then “bam”, the unexpected happens, your car is hit and now you wish that you had insurance that would cover it. This happened this week, the data was good, earnings good too, but the Chinese have been fighting inflation for the last month and the new market participants have been buying in, at higher prices I might add, with no real sense of managing the downside. Well, the weak longs are being washed out and if you are a bull, you would most likely see a little more of a flush before the bid bites back and resumes to the upside. Review your holdings this weekend and make sure that there is a plan in place to handle the potential volatility. Have a good weekend and see you Midday.

Stocks opened modestly lower after market volatility ticked higher across overseas markets Friday. Shanghai's Composite Index sank 5.2 percent after data showed a larger than expected jump in inflation in China during the month of October. Worries of inflation and possible rate hikes sent stocks broadly lower across China and triggered a ripple effect across global equity markets. However, trading in the US was orderly early and heading into the UofM consumer sentiment index, which showed an improvement to 69.3 in November, from 67.7 the prior month and slightly better than the 69.0 reading that economists had expected. However, stocks suffered another round of selling pressure later after the Federal Reserve experienced a technical glitch in its first day of Treasury purchases. The Fed was expected to buy bonds as part of its QE2 monetary policy today. The news sent stocks skidding into midday and, from that point forward; trading was somewhat choppy and uninspired. At the closing bell, the Dow Jones Industrial Average was off 90 points and the NADSAQ lost 37.3.

Bullish Flow
The top equity options trades Friday were in Citigroup (C). It was part of a spread. Shares lost 7 cents to $4.29 on the session and one strategist apparently bought the June 4.5 – 5.5 call spread for a net debit of 30 cents, 56800X. That is, they bought 56800 June 4.5 calls at 47 cents and sold 56800 June 5.5 calls at 17 cents. It looks like a new spread because volume exceeds open interest in both contracts. It also looks like an aggressive high risk-high reward play. This net cost is 30 cents (excluding commissions) and the possible pay-off is $1.70 if shares rally to $5.5 (28.2 percent) or more by the June options expiration. If shares fail to move above $4.5, the entire debit is at risk.

Bullish options action was also seen in Disney (DIS), ADP, and Nexen (NXY).

Bearish Flow
CF Industries (CF) shares sank on a rough day for the fertilizer names. The sector was under pressure Friday on falling agricultural commodities. Sugar lost 11.6 percent and suffered its biggest loss in 8 years. It is down 21 percent during the past two days. Consequently, some investors turned bearish on the fertilizer names and CF finished the day down $8.10 to $119.65. Options volume hit 3X the usual, driven by heavy trading in November 120, November 115, December 115, and January 115 put options.

Bearish flow also picked up in Fairchild (FCS), Green Mountain Coffee Roasters (GMCR), and MetroPCS (PCS).

Index Trading
The CBOE Volatility Index (.VIX) sees two days of gains, as market volatility seems to be picking up across global financial markets. VIX gained 1.92 to 20.56 and has added 11.3 percent since Wednesday. The rise in the volatility comes amid a noticeable increase in index options activity. 744,000 puts and 601,000 calls traded across the S&P 500 Index (.SPX) and other cash indexes, according to data from Trade Alert. Since VIX tracks the expected volatility priced into SPX options, it tends to rise when portfolio protection (SPX puts) are in higher demand. Meanwhile, 151,000 calls and 171,000 puts traded on the VIX itself.

ETF Trading
SPDR S&P Oil and Gas Exploration and Production ETF (XOP) saw interest for a second day. As noted in yesterday's wrap, December 47 puts were busy Thursday. At the end of the day, 25,700 traded. Open interest increased by 25,700 to 35,981 and now the largest position in the XOP. Players were paying between $1 and $1.03 to open new positions. Then, the December 44 put was active Friday. Shares lost 89 cents to $48.04 and one player paid 54 cents per contract for 18,000 contracts. The large put buying in this exchange-traded fund looks like bearish trading or possibly hedging activity on concerns about the outlook for major oil companies. XOP holds shares of companies like Exxon and Chevron.