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Sentiment

Manic-depressive action continues Tuesday, as the Dow Jones Industrial Average has erased morning losses and recovered the entire 132-piont drop suffered the day before. With no significant economic news to guide the morning action, the underlying tone of trading was cautious following another uptick in Spanish bond yields and after Fitch downgraded a handful of Spanish banks. Anxiety levels are also elevated across the Eurozone ahead of weekend elections in Greece. However, European stock indexes held most of their gains into the close and the Dow had erased its losses through midday. Another round of buying interest surfaced in the second half of trading. With fifteen minutes left to trade, 29 of the Dow thirty are holding gains and the industrial average is up 159 points. The tech-heavy NASDAQ gained 32 points and is 2 points from session highs. CBOE Volatility Index (.VIX) hit a morning high of 23.9, but is now down 1.15 to 22.41 amid light volumes in the options market. 7.4 million calls and 6.6 million puts traded across the exchanges so far.

Bullish Flow

IMAX adds 61 cents to $21.46 and options volume on the movie theatre company is running 9X the daily average, being driven by a Jun 21 - 22 call spread, apparently sold at 45 cents, 17000X. It might roll a position in Jun 21 calls opened last week for 30 and 35 cents. Shares are up 11.7 percent since Jun 4 and positions are being liquidated at $1.10. A new bullish position in Jun 22 calls is being opened for 65 cents and, if so, the big spread seems to reflect expectations for additional gains in the stock through the remainder of this week. The company hosts an annual Investor and Analyst day tomorrow.

Bearish Flow

You've probably heard the exaggerated statistics like 80 to 90 percent of options expire worthless. The truth is most options are closed out prior to the expiration through offsetting transactions. Some are exercised (assigned) and some do indeed expire worthless. But the fact that options expire worthless isn't necessarily a bad thing. In fact, some strategies take advantage of the fact that options are wasting assets. In that respect, a hefty short strangle on Chinese Internet company RenRen (NYSE:RENN) today highlights how "smart money" uses options to profit from time decay.

RenRen shares were flat at $4.55 today and one player sold 10,000 Oct 4 - 5 strangles on the stock at 98 cents, 10000X on ISE. A firm sold both contracts to open, according to ISEE. That is, they sold 10,000 October 4 puts on RENN at 52 cents and sold 10,000 October 5 calls at 46 cents. The credit is .98 or $98 per contract. On 10,000 contracts, the premium collected is $980,000, which is the max potential payoff from the short strangle. If shares settle between $4 (~12.1%) and $5 (~9.9%) through the expiration, both the Oct 4 puts and Oct 5 calls expire worthless and the strategist pockets the credit.

A short strangle is not really a bullish or bearish position. It targets rangebound trading and the breakevens are equal the strike of the put minus the credit and the call strike price plus the credit. In this case, if shares hold between $3.02 and $5.98, the Oct 4 - 5 short strangle at 98 cents makes money. In other words, the position will only suffer losses if the stock moves more than 33 percent lower or in excess of 68 percent to the upside. The trade makes sense because, despite a volatile two-month 37.3 percent decline, RENN has been in a range since early-October. The stock is at the same levels today as on Oct 4, 2011 and the strategist is betting that the stock will be around the same levels in October 2012. Of course, the position can also be bought-to-close at any time prior to the expiration.

Implied volatility Mover

Implied volatility in the options on St. Jude Medical (NYSE:STJ) is up sharply today after a physician reported a problem with a Durata brand lead wire from an implantable defibrillator in a single patient. Shares are down $2.54 to $36 today on heavy volume of 13.5 million shares. 15,000 puts and 5,400 calls traded on the medical device-maker. July 35 puts, June 37.5 puts and June 35 puts are the most actives and 30-day ATM vols jumped 33.5 percent to 40.

Source: Tuesday Options Recap