Options Trader: Thursday Morning Ideas

by: Philip Davis

Sideways into the weekend or do we try to break out?

This has got to be the worst rally ever! Incredibly, the VIX has gotten LESS volatile than it was when we couldn’t believe how low it was back in November. Needless to say, this is great for our long-term plays, where we sell options against our leaps, but not so good for our short-term plays, which are still a mixed bag.

CBOE SPX Market Volatility Index

This is now month five of what one might call VIX consolidation for a huge rally in volatility. There is one school of thought that the rise of options trading and hedge funds and the more fluid availability of good information have wrung the volatility out of the market and, looking at the three and five year charts that does seem to be the case.

It is also possible that we are merely experiencing the calm before the storm as the last time we had this kind of consolidation pattern in the VIX was the early 90s, during the first information revolution, as the VIX flatlined from 1993 through 1995 (yes there was one spike), when it finally exploded from 12 to a peak of 40 during the .com boom.

There is nothing so far to dissuade me from my bullish premise on the global economyy that caused me to predict a major rally back in August - that was 1,500 Dow points ago so not a terrible call considering most people were in the doom and gloom camp with $75 oil (but they all believed it was going up!). When you have time, you can review my very charty article that I put up later that week, see if you recognize the patterns I predicted.


Patterns are forming up in Asia as they too are holding the high ground, albeit 40% higher ground than we are holding. Don’t worry, either we’ll catch up or they will collapse biblically…

North Korea’s envoy says he is ready to discuss disarmament in the talks that the EU forced us to participate in (darn, and it was going to be such a fun war!). Our allies in Japan are still disarming from WWII as they are asking for an extension on removing 660,000 chemical weapons they left in China.

Earlier this year, a group of Chinese plaintiffs sued the Japanese government for compensation after 44 people were sickened — including one who died — when construction workers in China’s Qiqihar city in 2003 broke open a barrel of poison gas left behind by Japanese troops in World War II. Two other similar lawsuits by other groups of Chinese are pending in Japan.

On a happier note, Mazda [part of Ford (NYSE:F)] reported a 46% rise in net profit for the quarter as U.S. car sales drove the company to a $123M profit, just a LITTLE shy of offsetting Ford’s $5.8Bn loss for the same quarter but thanks for doing your best guys!

UMC had a great quarter but gave the standard "global semi-conductor glut, seasonal slowdown, prices falling" outlook that tends to freak out the markets. Wrong! I will say this again and I’ll get Tinkerbell back here if I have to, but Semis are not tech - they are the stuff tech is made out of! The supplies are cheap and plentiful, not great for the SOX but totally great for the companies that buy their stuff. Nonetheless, United Microelectronics Corp.'s (NYSE:UMC) CEO says the second half of the year looks good, which should be FABULOUS for the Nasdaq…

The E.U. should give the dollar some support today by doing nothing with their interest rates. With a U.S. Fed boost still on the table and the E.U., BOE and BOJ standing pat, we should still get a few customers for our treasury auction. Europe is trading off a bit but things will get interesting soon as the NYX/Euronext deal is moving closer to reality.

"The new company, with about 3,500 employees, will list shares of 80 of the 100 largest companies in the world ranked by market value, including General Electric and Total SA. It will be a major player in the fast-expanding futures and options markets, or 'derivatives' whose contracts derive value from other instruments such as bonds and commodities."

In January, NYSE expanded its alliance with the Tokyo Stock Exchange and agreed to pay $115 million for 5% of India’s National Stock Exchange. NYSE would also like to expand further in China.

This will be a long, painful merger that will yield a global powerhouse and very likely lead us to 24 hour a day trading in a few years (which I would love, because I don’t sleep anyway!).

Our markets are not looking too excited about opening today so we’re pretty much looking just to hold levels we hoped to hold (and did) yesterday:

• Dow 12,650 needs to hold.
• Transports need to get back over 2,875.
S&P just needs to hold 1,450.
• NYSE might hold 9,350, which would be excellent!
• Nasdaq is our problem child, 2,500 is 29 long points away.
• SOX holding 470 would be thrilling - keep clapping people!
• RUT 810 should hold - this is our real market leader right now!


You’ve got to like our chances!

Oil is probably not going anywhere today. We’re not going to go crazy as we are coming into the weekend and Nigerian rebels are standing by, waiting for word on who’s turn it is to have their employees kidnapped for a few days (next time you’re taken hostage, try the rebel camp chili - it’s great!).

Now we need to watch my $58.50 level for upside danger but we also have to seriously consider hitting my $56 target a little ahead of schedule. $57.40 is the mid-point breakdown but below $56 we should fall by $2s back to $50 where they will likely prop it up again. Of course, these are shenanigan-free numbers and that never lasts long, so we’ll just line up some plays that make sense regardless.


Only a dollar breakout will give us real certainty to bet oil straight down, otherwise we need to play carefully in this early stage correction. We have a big gas draw coming today at 10:30 but it’s the other gas, gasoline that’s giving trades fits now as ZMan points out that Americans are just not using enough of it!!

U.S. Gasoline Stocks

This is what happens when just 1M people don’t buy SUVs for two years! Demand destruction hits much harder and lasts much longer than our lemonade barons at OPEC seem to understand and they just blew their best chance to ease buyer’s concerns coming into the spring buying season.

Greed kills and I’ve never seen more over the top greed than the group that was ushered in with Enron and has blossomed into a global cancer of oil ministers, hedge funds, energy traders and retail operators who are squeezing an EXTRA $600M a day out of the pockets of U.S. consumers ($2.5Bn globally) for the same stuff, coming out of the same hole in the ground in the same quantity as it did in 2004 when it cost $30 a barrel (and they made PLENTY of profits then).

If the E.U. adopts a hawkish posture (a raise is pretty much out of the question), then the focus goes back to our budget and whether or not the International community thinks Congress can put a muzzle on Bush’s spending frenzy. This is a case where a lame-duck session of Congress will not be good for the markets as we need some decisive action to restore faith in our currency.

Gold will continue to be our leading indicator, and we just need to hope it doesn’t break $660 as it will be an excuse for commodities of all stripes to break out the rally caps.


Let’s keep an eye on the HBC had a disaster in its sub-prime portfolio with a 20% projected loss on bad debts. This is NOT indicative of a problem in the industry as HSBC Holdings (HBC) tried to corner the market on sub-prime mortgages, gambling that rising home prices would wash out the risk. They bought every junk loan they could find right at the top of the market and now they are taking a $1.76Bn hit for making a mistake.

While this may be the straw that broke the camel’s back for the HBs - it shouldn’t be. This is just the culmination of oil news but that’s no reason not to jump on our favorite put plays in the portfolio (including ones we gave up on last week) as Toll Brother's (NYSE:TOL) earnings and guidance was pretty weak too!

I’m going to be revisiting the insurance sector plays that we made on 12/11, but let’s see how the market shakes out today as the futures are deteriorating pretty rapidly in pre-markets - so expect a busy day in comments!