Tuesday Options Recap

by: Frederic Ruffy


Stocks suffered another round of losses, but the major averages are well off session lows late Tuesday. The stage was set for a rough day on Wall Street after Asian markets fell on worries about escalating tensions between North and South Korea. European benchmarks also suffered declines amid ongoing weakness in the euro and worries about the European sovereign debt debacle. Events overseas continue to overshadow domestic news and, with less than an hour left to trade, the Dow Jones Industrial Average is down another 105 points. However, today’s decline was orderly and the industrial average has managed to climb more than 180 points off session lows. The CBOE Volatility Index (.VIX) is down .94 to 37.38, but trading in the options market remains defensive. About 7 million calls and 9.1 million puts traded so far.

Bullish Flow

Pfizer (NYSE:PFE) is down 22 cents to $15 and the top trade in the name so far is a block of 6750 Dec 15 calls on the $1.39 bid. Looks tied to 675K shares at $14.99 and part of a buy-write. Remember that a buy-write is the same as a “covered call” and one of the first strategies many options traders learn. In this trade, the investor simply buys shares and sells calls — selling 1 call for every 100 shares.

Using the Pfizer example, assuming shares are trading for $15 and the investor sells December 15 (at-the-money) calls at $1.40, the cost basis of owning shares is $13.60 (or $15 minus the $1.40 premium received for selling calls). If shares fall below $13.60 by the December expiration, the investor will suffer a loss. If shares trade at $15.00 or more at expiration, the calls will be assigned and shares called away at $15, for $1.40 profit per share. Therefore, the maximum profit is at $15 and equals $1.40, or 10.3 percent

Finally, if shares trade between $13.60 and $14.99, the calls probably won’t be assigned. The profit equals the stock price minus the $13.60 breakeven. At expiration, the calls will expire worthless and the strategist can 1) hold the stock, 2) sell more calls, or 3) exit the position. Importantly, like with any options strategy, the covered call can be closed out through an offsetting transaction at any time prior to expiration.

Bearish Flow

The top options trade so far today is a block of 66,962 Freddie Mac (FRE) Oct 1 puts bought at 25 cents. 70K now traded vs. 72K in open interest. The action likely closes out a position accumulated from late Feb to late April. The most recent is 20K on the 6-cent bid on April 29. Shares are down 3 cents to $1.16 today and down almost 25 percent since then. Another 20K were apparently sold-to-open at 7 cents on Mar 25.

Implied Volatility Movers

iShares South Korea Fund (NYSEARCA:EWY) is down $2.48 to $41.04 amid escalating military tensions on the Korean Penninsula. North Korean leader Kim Jong Il has ordered military to combat alert and tensions have been building since international investigators said that Pyongyang was responsible for the deadly sinking of a South Korean warship two months ago. The options action is interesting. The top trades include Jun 44 – 48 call spreads apparently bought-to-open at 90 cents on the ISE and seem to be bullish short-term plays on the ETF. The spread has traded more than 11,500X. Meanwhile, another player appears to be bracing for additional volatility and paid $6.45 for July 41 straddle, 5000X (was tied to shares at $41 on a 5 delta). The action has implied volatility up about 15 percent, to 53, and a new 52-week high for the ETF.

Unusual Volume Movers

AT&T (NYSE:T) options volume is running 2X the usual, with 75,000 contracts traded and call activity representing about 53 percent of the activity.

Select Sector Tech Fund (NYSEARCA:XLK) options activity is running 2X the usual, with 61,000 contracts traded and call action representing 77 percent of the volume.

Boston Scientific (NYSE:BSX) options volume is running 5X the usual, with 47,000 options traded and put volume representing 97 percent of the activity.

Unusual volume is also being seen in FedEx (NYSE:FDX), Annaly Mortgage (NYSE:NLY), and Select Sector Discretionary (NYSEARCA:XLY).