Two Strategies for Bearish & High IV Sentiment 11-24-2010

Cusick's Corner
This market has performed pretty admirably, especially when you consider the action in the EU and Korea, the raids in the hedge funds and the fact that volume has been light. Let's continue to discuss strategies, specifically ones that could be useful if you are bearish and implied volatility is high: 1) Sell at-the-money call credit spreads. 2) Buy out-of-the-money put butterflies. In the first example, you are selling an at-the-money call, trying to take advantage of time decay, and purchasing an out-of-the money call as protection against the underlying moving to the upside. The butterfly is more of a targeted strategy, where the max profit is at the strike you sold, known as the body, and you have these two other long legs, the wings which is why it is called a butterfly, as protection and profit. The traditional ratio is buying 1 contract on the wings and selling 2 contracts in the middle of the wings. These strategies can be appropriate if you are bearish and the implied volatility is high. See you After Hours.

Stocks are broadly higher following a very busy morning of economic data. After a 143-point drop Tuesday, the Dow Jones Industrial Average opened higher after the Labor Department reported that filings for jobless fell by 34,000 to 407,000 last week, which was much better than the 1,000 increase that economists had expected. Separate data showed personal spending up .5 percent in October, which was .1 percent better than expected. The latest Durable Goods orders fell well short of expectations, falling 3.3 percent in October (vs. -.3 percent consensus). New Home Sales also fell more than expected, to an annual rate of 283,000 in November (vs. 314,000 consensus). However, the University of Michigan consumer sentiment index rose to 71.6 in late November, up from 69.3 earlier in the month and better than the 69.3 reading that economists had expected. A modest rebound in the euro and $2.42 rally in the price of crude oil seems to be helping fuel bullish sentiment on Wall Street Wednesday as well. The Dow Jones Industrial Average is up 134 points and the NASDAQ gained 47 through midday. The CBOE Volatility Index (.VIX) lost 1.77 to 18.86. Trading was active early, but is beginning to slow, as players hit the exits early ahead of the Thanksgiving holiday. 3.4 million calls and 2.7 million puts traded through 12:00 ET.

Bullish
Tiffany (TIF) calls are seeing brisk trading, as shares rally around better-than-expected third quarter earnings. The New York-based jeweler also raised its guidance for the full year. Shares jumped $2.83 to $61.10 and options volume is running 3X the average daily. 9,000 calls and 3,000 puts traded in TIF so far. The top trades look like a combination, in which the investor sold 1,640 Jan 60 calls at $3.45 to buy 1,550 Jan 50 puts at 50 cents. This might be a closing trade after today's move higher in TIF. Beyond that, most of the action is smaller lots. December 60, December 65, and January 60 calls are the most actives.

iStar Financial (SFI) adds 30 cents to $5.69 and more than 6,300 July 6 call options have traded on the day. Most of the action is part of covered call strategies, according to a source on the exchange-floor. For example, one strategist sold 2,000 at $1.25 against shares at $5.61. This trade will perform well if shares move higher through the March expiration. If the stock is above $6 when the options expire, the calls will be assigned and shares sold at $6, for a gain of 37.6 percent (excluding commissions).

Bearish
Put volume is picking up in the SPDR Homebuilders Trust (XHB). Shares are up 35 cents to $15.75 despite housing data that showed new home sales falling by 8.1 percent in October. Yet, while shares are up, sentiment in the options market seems a bit more cautious, as 23,000 puts and 6,000 calls have traded on the homebuilder ETF. December 18 puts are the most actives. 13,500 have changed hands. December 16, December 17, and January 17.5 puts are seeing interest as well. Put buyers are active in the ETF, possibly bracing for increased volatility in the housing sector over the next few weeks.

Infinera (INFN), a Sunnyvale, CA communication equipment company, put options are active Wednesday. Shares hit a high of $8.59, but saw a midday slide and are down a nickel to $8.37. Options action is heating up as well, 3X the average daily. 5,550 puts and 235 calls traded on the ticker so far. Most of the action is in the January 2011s. 10, 11, and 12.5 strike prices are the most actives.

Unusual Volume Movers
Industrial Select Sector Fund (XLI) options volume is running 9X the usual, with 138,000 contracts traded and put volume accounting for 98 percent of the activity, according to data from website WhatsTrading.com.

Consumer Discretionary Fund Select Sector Fund (XLY) options activity is running 14X the usual, with 121,000 contracts traded and put volume representing 99 percent of the volume.

Airgas (ARG) options volume is 2X the typical levels, with 43,000 contracts traded and call volume accounting for 75 percent of the activity.

Increasing volume is also being seen in Tellabs (TLAB), Cree Research (CREE), and Deere (DE).

Implied Volatility Movers
CBOE Volatility Index (.VIX) is under pressure. The market's “fear gauge” jumped 2.26 points to 20.63 Tuesday. However, with the S&P 500 Index up 15.3 points and, having recovered most of Tuesday losses, VIX is down 1.67 to 18.96. Moreover, tomorrow is a holiday and Friday is a half session. There are no more economic releases scheduled for the remainder o the week. Consequently, volume is slowing and volatility is easing ahead of the break midday Wednesday.