How Low Can We Go? 07-27-2011

Cusick's Corner
The market in the After Hours is trading below the lows of the day, and if this budget debacle does not get a resolution, well the market will take on water fast. I am going home in cash and I have a small short exposure in the bonds through a Bond put spread, if this debate could get resolved, bonds might be the first to get pressured, and the Dollar/Euro action could be the flag that would signal that upcoming pressure. After a weak Durables number, the Claims data due out before the open will be watched closely to see if the recovery is in danger because of slower than expected payroll growth. See you Midday.

Weak economic data and concerns about the US debt situation set the table for morning weakness on Wall Street and the pace of selling gathered additional momentum Wednesday afternoon. A report released before the opening bell on Wall Street showed orders for Durable Goods down 2.1 percent in June. Economists were expecting an increase of .5 percent. A profit warning from Juniper Networks (JNPR) and weak sales growth at Emerson Electric (EMR) added to concerns about the economy. Much focus remained on Washington as well, where budget talks in the House and Senate seem to be making little progress heading into an August 2 deadline to raise the debt ceiling. The Fed's Beige Book, which offers a qualitative assessment of economic conditions, was released Wednesday afternoon. The report failed to stir the bulls, as it noted a slowing pace of economic growth. So stocks remained under pressure in the final hour of trading and, at the closing bell, the Dow Jones Industrial Average was down 198 points and not far from session lows. The tech-heavy NASDAQ lost 75.2.

Bullish
Williams Companies (WMB) saw relative strength and interesting options activity today. Shares of the natural gas producer gained $1.48 to $32.10. Options volume was impressive, as 191,000 calls and 62,000 puts traded in WMB today. One of the top trades of the day was a strangle. In this trade, the strategist sold 16,400 September 35 calls at 85 cents and sold 16,400 September 32 puts at $2.15. In other words, the Sep 32 - 35 strangle was sold at $3, 16,400X. Volume exceeds open interest in both contracts. So, the trade appears to be a new position. This strangle sale isn't really a bullish or bearish play, but a bet that shares will hold between $32 and $35 through the expiration. The range of profitability is between $29 and $38, with significant losses possible if WMB makes a dramatic move higher or lower.

Bullish trading was also seen in Ensco (ESV), IAC Interactive (IACI), and Yahoo (YHOO).

Bearish
One of the biggest equity options trades so far today was in Microsoft (MSFT). Shares of the software giant finished the day down 75 cents to $27.33 and were among 28 Dow stocks to finish with losses today. In options action, one investor sold 23,000 January 25 calls on Microsoft at $3.30 per contract. 33,000 contracts changed hands and open interest is 123,131. The activity might be liquidating trades. In other words, bullish investors are taking in these in-the-money calls off the table amid diminishing hopes for a rally in shares through January 2012. MSFT is up 15.5 percent from the lows seen in mid-June, but after today's slide, is showing a modest loss year-to-date.

Bearish flow also surfaced in Corning (GLW), Jabil Circuits (JBL) and Carmax (KMX).

Index Trading
CBOE Volatility Index (.VIX) continued its run higher. After recapturing the 20 level yesterday, the market's "fear gauge" gained another 2.75 to 22.98. VIX is up 28.2 percent on the week and started climbing Monday after politicians failed to break a stalemate over budget plans over the weekend. Nervousness grows each day no agreement is made, as the August 2 deadline to raise the debt ceiling looms. Consequently, demand for portfolio protection is beginning to rise. 564,000 puts and 207,000 calls traded on the S&P 500 Index (.SPX) today. As a result, VIX, which tracks the expected volatility priced into SPX options, recorded its third straight gain and closed at its best levels since mid-March.

ETF Action
SPDR Industrial Fund (XLI) saw increasing put volume today. XLI lost 98 cents to $35.15 and options activity in the ETF included 117,000 puts and 13,000 calls. Two of the top trades in the XLI today were part of a spread, in which the investor bought 10,000 August 35 puts at 58 cents and sold 10,000 August 32 puts at 10 cents. That is, they bought the Aug 32 - 35 put spread for a 48-cent net debit, 10000X. It's a short-term play, as August options on the XLI expire in 23 days. The potential pay-off (excluding commissions) is $2.52 if shares fall to $32 or less during that time, which represents a decline of about 9 percent. XLI is a fund that holds GE, Caterpillar, United Technologies and the other "industrial" components of the S&P 500.