Adding Yield to Your Porfolio - Muni Bonds 12-29-2010

Cusick's Corner
Today I want to talk a little about adding yield to your portfolio, specifically municipal bonds. Muni bonds are issued by state and local governments to finance everything from road projects to school construction. Munis, as they are often called, are often not subject to federal, state, or local taxes if issued in the municipality where you reside (please consult a tax advisor). Right now there are munis that are yielding 6-8%, but unlike treasuries, they potentially carry risk due to the turmoil striking many state budgets, and I live in one of the worst states -- Illinois. However, like the banks in 2008, it is unlikely that the Fed will let these states default and these yields, almost 2X of treasuries, might be worth the risk. Now solvency and credit worthiness are critical points in measuring up the quality of the bond and does not turn a blind eye to the fact that the bond has a high yield. High-yield muni bonds are among the most risky because they are issued by smaller or less stable municipalities. But if you seek out yield at this stage, munis might be worth looking at. See you After Hours.

Major averages are sporting modest gains on another day of slow trading Wednesday. With no economic data or earnings of broad market significance, there wasn't much news to drive the early trading. Action in the commodities market continues to get some attention, as silver and copper are approaching record highs. Beyond that, there are no real catalysts to drive trading and the Dow Jones Industrial Average is drifting in another narrow 46-point range. The Dow is up 30 points midday. The NASDAQ has added 5.75. The CBOE Volatility Index (.VIX) edged down .29 to 17.23. Options volume is light, with 2.3 million calls and 1.9 million puts traded through 11:00 ET.

Bullish
Sears Holdings (SHLD) is seeing relative strength and increasing options action. Shares are up $4.54 to $74.56 and one of the best gainer in the NASDAQ 100. Meanwhile, options volume is 3.5X the average daily. 9,235 calls and 5,295 puts traded through midday. January 75 calls, which have traded 1,800X, are the most actives. Jan 80 and 85 calls are busy as well. There is no company specific news to explain the action, but the strength in the stock might be delayed reaction to news yesterday that it was planning on launching an online movie download service called Alphaline Entertainment. The service allows Sears and Kmart customers to download entertainment online.

Noble Energy (NBL) adds $2.46 to $87.44 and touched a new 52-week high after the driller announced a significant discovery in the Leviathan Offshore Israel region. Shares are rallying and options volume in NBL includes 7,850 calls and 1,990 puts. January 90 calls, which traded 4,400X, are the most actives. Some players appear to be buying these out-of-the-money calls in anticipation of additional gains in NBL through the January expiration, or 23 days.

Bearish
Some large put spreads traded of a couple of exchange-traded funds [ETFs], as some fund managers might be hedging their bets heading into 2011. For example, in the PowerShares QQQ (QQQQ), which is up 18 cents to $54.85, one strategist apparently initiated a March 48 – 54 put spread at $1.23, 30000X. That is, the investor bought 30,000 March 54 puts at $1.65 and sold 30,000 March 48 puts at 42 cents. This spread has a downside breakeven (excluding commissions) at $52.77 and offers a max payout if shares fall to $48 by the March expiration.

The iShares Small Cap Fund (IWM) saw a similar spread trade. Shares are up 16 cents to $78.90 and the IWM March 70 – 77 put spread is bought at $1.70, 19000X. The strategist paid $2.93 for the 77s and collected $1.23 on the 70s. Like the QQQQ spread, this position makes its best profits if shares fall below $70 by the March expiration. An institution looking for a hedge into 2011 probably initiated these substantial bearish spreads Wednesday morning.

Unusual Volume Movers
iShares Japan Fund (EWJ) options volume is running 8X the usual, with 64,000 contracts traded and call volume accounting for 100 percent of the activity, according to data from website WhatsTrading.com.

Rare Element (REE) options activity is running 3X the usual, with 35,000 contracts traded and call volume representing 66 percent of the volume.

Hercules Offshore (HERO) options volume is 25X the typical levels, with 34,000 contracts traded and put volume accounting for 99 percent of the activity.

Increasing volume is also being seen in Agrium (AGU), Avon Products (AVP), and BJ Wholesale (BJ).

Implied Volatility Movers
Rare earth names continue to see a lot of interest (REE, MCP, SHZ). The rally in the group started Monday and then gathered additional momentum Tuesday after China announced plans to cut quotas on rare earth materials. Rare Element (REE), for example, is up $1.68 to $14.62 today and 44.7 percent on the week. Options volume is 3X the average daily after 24,000 calls and 12,000 puts traded. Meanwhile, implied volatility is up another 5 percent to 105 and has surged 44 percent on the week.