Market is Extended 01-03-2011

Cusick's Corner
This bullish market still has low volatility and is extended, so strategically traders may want to participate in this environment using spreads. Many bulls are potentially looking to buy at-the-money spreads, because the volatility is relatively cheap, and they do not have to lay out as much cash versus buying the stock outright (check out the Bullish BAC activity in the Midday). To further mitigate the premium risk, also consider selling out-of-the money call spreads. This takes advantage of not only taking in premium to offset the purchase price, but also mitigates volatility risk if the long option volatility drops and hurts your long position regardless of how the underlying is doing. There is no meaningful data tomorrow but you should gear up for the employment data that is due out later this week. See you Midday.

Major averages finished with gains, but off session highs Monday. The economy was in focus early after a report released in morning trading showed the ISM index of manufacturing activity increasing to 57 in December and for a 17th consecutive month. Separate data from the Commerce Department showed construction spending up 0.4 percent in November, and twice as much as expected. Meanwhile, BofA (BAC) gained 6.4 percent and led the Dow Jones Industrial Average on news of a settlement with Freddie and Fannie. Alcoa (AA) also helped the Dow after Deutsche Bank upgraded the stock to Buy. The upgrade comes one week before Alcoa kicks off the fourth quarter earnings-reporting season. AA gained 2.7 percent on the day. In all, 25 Dow stocks moved higher, four finished in the red, and the industrial average added 92 points. The Dow finished 40 points from its best levels. The tech-heavy NASDAQ gained 39.

Bullish Flow
Some players seized Citi (C) call options in afternoon trading Monday. Shares finished the session up 17 cents to $4.90 and several large blocks of calls traded just after 2:00pm ET. For example, two blocks (25,000x2) of January $5 calls traded at a dime. Another three blocks of 20,000 each also traded at ten cents per contract. In all, the volume in these blocks of Jan $5 calls totaled 110,000. In addition, all traded on the International Securities Exchange [ISE], where sentiment data indicate that an investor bought-to-open a new position. The hefty premium purchase seems to reflect expectations that shares will continue to climb through the January 2011 expiration, which is now 18 days away.

Bullish order flow was also seen in KB Homes (KBH), Manitowoc (MTW), and Pepsico (PEP).

Bearish Flow
Zion Bancorp (ZION) was the subject of a sizeable new position Monday. In morning trading, with shares around $25, the January 25 – 26 strangle traded at $1.19, 9,300X. A buyer initiated the position, and bought 9,300 of both the puts and calls, according to a source on the exchange floor. Volume exceeds open interest in both contracts and so this appears to be a new position. In addition, since the puts are at-the-money and the calls out-of-the-money, the strangle has a net negative delta and is a bearish play on the regional bank. The key to success, however, will be for the stock to make a volatile move in one direction or the other.

Bearish flow also picked up in Xilinx (XLNX), Nabors (NBR), and Newell Rubbermaid (NWL).

Index Trading
Options action in the index market finally picked up after a very slow week of trading in the final five days of 2010. 605,000 calls and 578,000 puts traded on the S&P 500 Index (.SPX) and other cash indices today which is 113 percent the recent average daily, according to Trade Alert data. The top options trades were in the CBOE Volatility Index (.VIX). VIX settled down .13 to 17.62 and one investor apparently sells 40,000 January 35 calls at 11 cents to buy 20,000 January 27.5 calls at 29 cents. They also sold 20,000 February 27.5 calls at 86 cents to buy 40,000 February 35 calls at 44.5 cents. This appears to be rolling, and opening a new backspread in the February calls. This position will make its best profits if VIX really rallies before the Feb expiration.

ETF Trading
SPDR Metals and Mining ETF (XME) puts were active for a second day. As noted in Friday's wrap, 24,000 puts and 3,300 calls traded on the fund on the last day of trading in 2010. March 60 puts are the most actives. The activity continued on the first day of trading of 2011. Shares notched a new 52-week high and finished up $1.33 to $70.11. Options volume included 22,000 puts and 1,165 calls. This time, March 62 puts were the most actives. 13,300 traded and, with 77 percent traded at the asking price, it appears that buyers were initiating the trades. If so, this might be hedging activity or outright bearish bets against the mining and metals names.