Wednesday Options Recap

Sentiment

Stocks traded in a narrow range throughout most of the morning session, but then faltered late and GM (GM) is leading the Dow Jones Industrial Average to a triple digit loss Wednesday. Shares of the automaker are down more than 17 percent to $1.19 on news some GM bondholders voted against converting debt to shares, which rekindled bankruptcy concerns.

GM is one of 25 losing Dow stocks. Some of the cyclical names, like DuPont (DD), 3M (MMM), and GE are seeing relative weakness as well.

On the economic front, the day's news included only one stat. A report released thirty minutes into the trading session showed existing home sales increasing to an annualized rate of 4.68 million in April, up from 4.55 million the month before and not too far from economist estimates of 4.66 million.

The existing home sales number proved to be a non-event, however, and the focus seems to be the troubles facing GM and a sharp sell-off in bonds, which was triggered by news of a poor auction of Treasurys. The benchmark ten-year is getting slammed for a 1 point loss.

After rallying 196 points Tuesday, the Dow Jones Industrial Average is down 140 points late Wednesday. The CBOE Volatility Index (.VIX) hit a low of 29.62 in morning trading, but has moved higher and is up .72 to 31.35 ahead of jobless claims, durable goods, and new home sales numbers Thursday. With about 45 minutes left to trade, 4.5 million puts and 5.9 million calls traded so far.

Bullish Flow

Nucor (NUE) is up $1.13 to $42.28 on a good day for steel stocks (X, AKS, STLD.) The sector is showing relative strength after a Jefferies analyst said steel distributors are poised to benefit from an eventual uptick in demand. New orders for the metal will surface as inventories have declined and the broader economy improves. In NUE options, volume is running 2X the normal levels, with 13K puts and 10K calls traded. The top trade of the day is 4500 Jul 40 puts, which was bought for $2.30 and tied to a position in 153K NUE shares at $43.25.

iShares Japan Fund (EWJ) is down 9 cents to $9.35. At least one strategist expects the exchange-traded fund to stay around $10 during the rest of 2009 and is playing it with a substantial January 2010 straddle. 25K Jan 10 (2010 at the $10 strike) straddles were recently sold for an average of $1.675. Looks like new positions in both contracts and, if so, one that yields a profit if EWJ closes between $8.34 and $11.67 at the January expiration. The ideal scenario: EWJ moves to $10 and both puts and calls expire worthless at expiration.

Bearish Flow

Citi (C) June 4 call is the most actively traded equity options contract in the first hour of trading. 35.9K traded. The top four trades (1874, 1000, 1000, and 919 contracts) all hit bid-side for 15 and 16 cents. The trades are possibly closing sales, opening sales, or buy-writes. A straight call write would be a bearish bet that Citi shares will stay below $4. However, the call selling might also be part of a buy-write strategy.

Recall that, in a "buy-write" or covered call strategy, the investor buys shares and sells calls against the stock. Generally, 1 call is sold for every 100 shares. In the Citi example, some investors are possibly selling June 4 calls and buying Citi shares.

At recent prices, the investor can buy Citi for $3.76 and sell the June 4 calls for 16 cents. Since the multiplier for a call option is 100, the strategist collects $16 in premium (100 X .16), which offsets the cost of the stock. Therefore, they pay $376 for 100 shares and receive $16 for selling the call. The cost of owning the stock falls to $360, or $3.60 per share, which is the trade's breakeven. If the stock is below that price level at the June expiration (23 days), the trade loses money. However, a move higher, and the position begins to show better results.

A move to $4 or higher will result in assignment and, if so, the strategist sells (has called away), Citi for $4 and an 11.1 percent profit in a little more than 3 weeks. However, the short call or the entire position can be closed at any time. Also, if shares move just below $4, the call will expire worthless and the investor keeps the shares and can possibly sell the July 4 or 5 call.

Implied Volatility Movers

Implied volatility eased in Sandisk (SNDK) after the company announced a new licensing agreement with Samsung Wednesday. Options volume picked up as the stock rallied $2.19, or 16.2 percent, to $15.77. Implied volatility fell to 67 from about 72 the day before.

Implied volatility is also lower in North American Energy Partners (NOA), Chico's (CHS), and Monsanto (MON). Meanwhile, implied volatility is higher in Banco Itau (ITUB), Cardionet (BEAT), and Applied Materials (AMAT).