Tuesday's Options Recap: Risk Perceptions Fall Sharply

Sentiment

Stocks are broadly higher and the major averages are near session their best levels heading into the final hour of trading. The equity market opened higher Tuesday with help from strength in the financials. HSBC (HBC), Europe's biggest bank, helped set a positive tone for overseas trading after rallying 11.9 percent and erasing all of the losses from the day before, when shares sank on fears of further write-downs.

In the US, the focus was on Citigroup (C) early in the day after the company's CEO said in a memo that his bank was profitable during the first two months of 2009 and that Citi's share price doesn't reflect its capital position or earnings power. Shares of the bank are up 37 percent and leading the Dow to a 320-point gain. BofA (BAC) rallied 26 percent and the remaining 28 Dow stocks are also in positive territory.

Investors seemed to find some solace from soothing words from Fed Chairman Ben Bernanke as well. Speaking to the Council of Foreign Relations, Bernanke said the recession might end by yearend. Finally, comments from Congressman Barney Frank seemed to give the benchmarks a lift in afternoon action. Frank says the uptick rule should be reinstituted and that the mark-to-market accounting rules need to be relaxed.

Risk perceptions are falling sharply. Gold lost $27 to $897 and the benchmark Treasury note gave up 1 point. In the options market, the CBOE Volatility Index (.VIX) fell 5 points to 44.68 and, with 45 minutes left in Tuesday's session, approximately 5.5 million puts and 8 million calls traded so far.

Bullish Flow

Nokia (NOK) is seeing a second day of bullish order flow. Yesterday, our scans picked up heavy trading in the April 9/11 call spreads, which traded 14000X. Today, shares are up 85 cents to $9.61 after Morgan Stanley named NOK as its long Research Tactical Idea. In the options market, focus is on the Mar 10 calls, with 25K traded, compared to open interest of 1,975.

Royal Carribbean Cruises (RCL) is up $1 to $6.81 and June 10 calls are actively traded. 4,659 traded and 100 percent hit ask-side. ISEE Sentiment data confirms the activity includes opening customer call buying. The bullish order flow comes ahead of a presentation at the Raymond James Institutional Investors Conference today at 4:35 ET.

Bearish Flow

Discover Financial Services (DFS) is up 75 cents to $5.96 after Stifel upgraded the stock to Buy from Hold, saying the company passed their "stress test". In the options market, volume is running 2X the usual, with 6,650 puts and 1,138 calls traded. Most of the activity appears to be part of a position adjustment, where a strategist sold 2,050 April 10 puts and bought 2X as many October 5 puts, possibly closing a position opened late last year when DFS was above $10 and opening a similar bearish position in lower strike puts.

iShares MSCI So. Korea Fund (EWY) is seeing bearish order flow for a second time in three days. Friday, investors showed interest in the July 21/16 ratio spread. Today, the April 15-18-21 put fly traded 3000X. Shares are up $2.00 to $24 and the strategist paid .375 per fly. Looks like a new trade, which we will explore closer in our premium section a bit later today.

Implied Volatility Movers

Comtech Telecomm (CMTL) implied volatility spiked higher. Shares are down 39 percent on earnings news. Trading in the options market is active, with 8,575 calls and 2,600 puts traded. Implied volatility rallied to 84, up from about 60 the day before.

Implied volatility is also higher in Aeroenvironment (AVAV) and not much else. Implied volatility is falling across the board, including big drops in BofA (BAC), General Electric (GE), and Citi (C).

Comments

[mac.barron:]

Looks like the start of another bear market rally is here for Wall Street; I'm mostly invested overseas now so I'll only be watching with one eye. This thing could run for up to six or seven trading days and net index gains of as much as fifteen to twenty per cent are not out of the question. Meantime, gold will continue to slide and the shorts will take a few deep bruises. Just don't anybody get to comfortable is all I have to say . . . I think we all know about what follows.

During the run-up the market will shake off a few bits of bad news then one item (a lowered guidance from someone listed on the Dow or a deeper than anticipated slide on housing starts) will send it all into a twist. Until the next inversion.

You can make some good money in these little mini-cycles with the option plays, maybe even have some fun too. In the end though, you have to keep your eye on the the U.S. Dollar's progress. So long as the Dollar is strong and inflation is not too bad things are fine. If the Dollar spirals down then the value of stocks will be punished like we have never seen.

I realize that this pronouncement is neither original or terribly insightful. It is also like saying "we're all okay so long as the earth isn't destroyed by a meteor." Still, loss of global confidence in the U.S. Dollar is the ultimate game changer. It is certainly enough of a potential problem that individual investors should, I contend, take prudent and reasonable steps to hedge themselves.

Mar 10 05:14 PM

[rayman:]

that was me on the KIE calls btw Fred......;-)

Mar 10 06:35 PM

[Adam Hayes:]

you can't really talk about these moves in %-age terms anymore. Though it does sound counter-intuitive..
If Citi rallies .40 likes yesterday.. yes it's a substantial % move but it only adds a small amount to its member indeces.
Also, 3 months ago a 8 point move in the S&P 500 was a fraction of a % change.. while now it is over 1%
It is tough to compare apples to apples in this market!
As for option volatilities, the VIX was in the 70s-80s back in Oct-Nov'08 .. now its in the low-mid 40s despite 12-year lows in the broad market! I think this all just points to overall confusion amongst investors and traders.

Finally, calls and puts are the same thing (once hedged) and something like 80% or more of all block option trades are delta neutral. So if 8000 calls and 2000 puts trade, great it's the same thing just say 10,000 options traded. If you want an explanation as to why hedged calls are the same as hedged puts you can message me and i will go into it. Furthermore, it has been established that put/call ratio and even overall options volume (as well as VIX and other vol. indicators) have virtually NO predictive power in terms of the underlying's future price action.

With that in mind, i think options are priced cheaply generally right now for this sort of economic environment.

my .02

Mar 11 09:06 AM

[Fred Ruffy:]

Thank you for the comments. Sounds like the KIE calls are working out well for you Rayman.

One clarification to the comment: "something like 80% or more of all block option trades are delta neutral".

Delta neutral implies that a position is perfectly hedged. For example, 100 shares of stock, which have a delta of 1.00, can be hedged with two puts that have negative deltas of -.5. This results in a position delta of 0 or delta neutral.

Over the 15+ years I have been active in the options market, including on an institutional trading desk, I can tell you with certainty that 80 percent of block options trades are not delta neutral. Options trades are initiated by buyers and sellers for a variety of reasons--sometimes to hedge, sometimes to speculate. True, a lot of the activity is tied to shares, but it is often on positive or negative deltas.

We monitor the activity throughout the day and write about the most interesting and noteworthy activity. Whether or not you feel it has predictive value is up to you, but consider a recent example from Friday--a surge in call activity in Schering Plough that occurred before the takeover announcement Monday. This was not a coincidence.

If you want to find out more about the tools we use and how we track the activity, we have a FAQ section on our web site that addresses many of those questions.

Good trading!

Mar 11 10:31 AM

[rayman:]

lol, out KIE calls....probably saw em on your site *wink* *wink*
150% return on the squeeze Fred...held for a few days I believe, but wish I kept my IBM/UYG calls, phenomenal day

I ike the notes on Delta Neutral Fred.
I went Delta neutral on EFA (well kind of) with a 33 strike straddle on the front month today. A wee bit upside, but I might pull it at a 10% loss if things don't work out right away. Looking for 20% upside.
I might be doing some conversions soon if I can find some (shouldn't be too hard to do if some more volatality comes in).

Mar 12 05:43 PM

[rayman:]

The delta neutral also sounds similar as well to this method: www.theoptionsguide.co... that I like as well. Good notes, keep up the great work! Seems almost worthwhile these days to get 2 puts against a position esp. if they get cheaper.

On Mar 11 10:31 AM Frederic Ruffy wrote:

> Thank you for the comments. Sounds like the KIE calls are working
> out well for you Rayman.
>
> One clarification to the comment: "something like 80% or more of
> all block option trades are delta neutral".
>
> Delta neutral implies that a position is perfectly hedged. For example,
> 100 shares of stock, which have a delta of 1.00, can be hedged with
> two puts that have negative deltas of -.5. This results in a position
> delta of 0 or delta neutral.
>
> Over the 15+ years I have been active in the options market, including
> on an institutional trading desk, I can tell you with certainty that
> 80 percent of block options trades are not delta neutral. Options
> trades are initiated by buyers and sellers for a variety of reasons--sometimes
> to hedge, sometimes to speculate. True, a lot of the activity is
> tied to shares, but it is often on positive or negative deltas.<br/>
>
> We monitor the activity throughout the day and write about the most
> interesting and noteworthy activity. Whether or not you feel it has
> predictive value is up to you, but consider a recent example from
> Friday--a surge in call activity in Schering Plough that occurred
> before the takeover announcement Monday. This was not a coincidence.
>
>
> If you want to find out more about the tools we use and how we track
> the activity, we have a FAQ section on our web site that addresses
> many of those questions.
>
> Good trading!

Mar 12 05:46 PM

[rayman:]

I need to due some more delta neutral (well - *kind of* trades. Doh, one more thing I thought of (of course). 50 shares of stock - then of course get 1 put. Same math I guess as 2 puts, but if the stock is expensive, simply keep the same ratio. If you like the stock, buy more on weakness or strength, rinse, lather repeat and if you make gains, try to use some of those gains to purchase another put. Could be really good for momentum stocks, and also very good downside protection.

Mar 16 10:59 PM