Option Strategies to Consider When Implied Volatility Relatively Low 02-28-2011

Cusick's Corner
The grind continues. If you are bullish and either raised cash from taking profits or just have some capital on the sidelines, what strategies could you consider? First take a look at implied volatility by going to the oX Volatility View and Chains. Overall market volatility is relatively low, VIX 18.35 vs. 6 months ago when it was at 30, plus the market is in a defined bull trend. With the view that volatility is relatively low and overall trend bullish, could look at buying 30-60 day calls or to mitigate premium risk, consider buying at-the-money calls and selling out-of-the-money calls to create a spread. Both strategies potentially allow you to participate in a bullish market while mitigating large cash risk with outright stock purchases. We have a great video on this very spread strategy, http://www.optionsxpress.com/free_education/on_demand_videos.aspx. See you Midday.

Stocks opened higher and finished mixed on upbeat economic news and end-of-month position squaring. Data released early showed January personal incomes and spending up 1 percent and .2 percent. Economists were looking for increases of .3 percent and .4 percent, respectively. The Chicago Purchasing Manager's Index, a gauge of regional manufacturing activity, was released later. PMI was up to 71.2 in February, from 68.8 the month before and much better than the 67.5 that economists had predicted. A third report showed pending home sales down 2. 8 percent, which was not as bad as the 3.2 percent decline that was expected. Beyond that, there wasn't much news to guide the action. Stocks were mixed after midday and then saw a late lift on end-of-month institutional buying. At the end of the session, the Dow Jones Industrial Average had gained 96 points on the day and 334 points for the month of February.

Bullish
Berkshire Hathaway (BRK/B) shares rallied after the Oracle of Omaha, Warren Buffett, made upbeat comments in his widely read annual shareholder letter. Berkshire Chairman Buffett said there is a need for his company to make major acquisitions, which seemed to give investors confidence that some stocks might still be cheap. BRK/B also rallied on the upbeat commentary. Shares gained $2.41 to $87.28 and notched a new 52-week high. Options volume included 17,000 calls and 7,835 puts. March 85 and April 90 calls were the most actives, as some investors might have been liquidating positions in the in-the-money March 85s while others appeared to be opening new positions in the April 90 out-of-the-money calls.

Bullish trading was also seen in Forest Labs (FRX), Coeur D'Alene (CDE) and Staples (SPLS).

Bearish
Power One (PWER), a manufacturer of power conversion and other power management products, lost 84 cents to $8.23 today. Increasing put volume accompanied the volatile move in the stock. 13,000 puts and 5,910 calls traded in the name. March 7 puts were the most actives. 5,400 traded and, with 97 percent trading at the ask, it looks like put buyers were dominating the action and bracing for additional weakness in PWER ahead of the March expiration, in 18 days. March 8 and 9 puts were busy as well. It's noteworthy because there were no obvious news items to explain the relative weakness in the stock or the increased put activity in PWER Monday.

Bearish flow also surfaced in General Dynamics (GD), Iron Mountain (IRM), and Kroger (KR).

Index Trading
Overall action in the index pits was slow today. 305,000 calls and 557,000 puts traded on the S&P 500 Index (.SPX) and other cash indexes, which is only 72 percent the recent average, according to Trade Alert data. One index that did see increasing volume was the Mini-NASDAQ 100 Index (.MNX). The index is equal to 1/10th the value of the NASDAQ 100 Index (.NDX), which in turn is the 100 top non-financial stocks listed on the NASDAQ Stock Market. The Mini-index added .47 points to 235.10 and options volume rose to 3X the average daily. 7,100 puts and 215 calls traded on the session. Most of the action was in the April and June 235 puts and are possibly time spreads, or buying the Junes and selling the Aprils. If so, these spread traders might be looking for the NASDAQ 100 to hold around these levels through April, then head lower from that point forward.

ETF Action
Energy Select Sector Fund (XLE) saw impressive put spreads today. XLE, which holds shares of all the energy-related companies from the S&P 500, finished the day up 60 cents to $78.54. Meanwhile, one strategist paid 99 cents for April 75 – 70 put spreads, 36000X. That is, they bought 36000 April 75 puts at $1.54 and sold 36000 April 70 puts for 55 cents. This might be a bet that shares will fall to $70 or less by the April expectation, or maybe to hedge a position in energy-related stocks. More than 67000 traded on the day.