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Sentiment

Stock market averages are holding solid gains late-Tuesday. Italy’s MIB Index gained 3.2% and led an advance across eurozone equity markets on diminishing concerns about the EU debt crisis after Spanish bond yields ticked lower today. In the U.S., data released early showed Housing Starts falling to an annual rate of 708K in May, from 744K and below expectations of 719K. However, Building Permits - a better gauge of future activity - jumped to 780K from 723K and much better than 725K that was expected. Hopes that Fed Officials will announced some further quantitative easing at the conclusion of the two-day FOMC meeting tomorrow afternoon is also helping to support stocks today. With less an hour to trade, the Dow Jones Industrial Average is up 128 points and 29 points from session highs. The Nasdaq gained 40. CBOE Volatility Index (.VIX) edged down .25 to 18.07 and now well off session lows of 17.36. Trading in the options market is active. 8 million calls and 7.25 million puts traded across the exchanges so far.

Bullish

Microsoft (NASDAQ:MSFT) adds 92 cents to $30.75 and is the second best gainer in the Dow behind BofA today. Trading is active, with 59 million Microsoft shares and 287,000 MSFT options changing hands after the company unveiled the new windows-based Surface tablet. Options order flow on the software giant so far includes 201,000 calls and 85,000 puts, which is almost 3X the daily average.

The top (largest) options trades in Microsoft today are part of a spread, in which the investor sold 15,000 Jul 31 calls on MSFT at 81 cents to buy 15,000 Jan 30 calls for $2.62. The Jul 31 – Jan 30 diagonal spread, for a $1.81 debit, traded 25,000X on ISE and is an opening spread, according to ISEE data. If so, the call spread seems to express confidence in the stock through early-2013, but expectations for limited upside through the July expiration (31 days).

The investor is taking a position in 25,000 January 30 calls and paying $2.62 in premium ($6.55 million) to lock in the right to buy (or call) 2.5 million shares for $30 through January 19, 2013. They are helping to finance the calls by writing (selling) 25,000 July 31 calls (that are 25 cents out-of-the-money) and collecting 81 cents per contract ($2 million). Doing so, they’re stating that they’re willing sellers of the stock at $31. As we can see from the risk graph, the best profits from the position happen if MSFT settles at $31 at the July expiration. At that point, the 31 calls, which are sold, expire worthless and the strategist can hold the Jan 30s or exit the trade entirely.

The risk to the diagonal spread is from a substantial move higher or lower in the stock. If shares fall, both contracts lose value and the entire debit can be lost if the position is left open and MSFT settles below $30 at the January expiration. If there is a substantial move to the upside, then assignment on the July 31 calls comes into play.

Microsoft shares are up 18.6% year-to-date thanks to strong gains in the first two months of 2012. MSFT touched a 52-week high of $32.95 in mid-March. By initiating the July 31 - January 30 call spread the strategist is basically stating that they expect shares to continue moving higher throughout the second half of 2012, but the stock might take a breather between now and the July expiration.

Bearish Flow

Aetna (NYSE:AET) adds 27 cents to $41.38 and July 42 – 46 call spreads are sold on the insurance company to buy July 36 puts, 66 cents collected on the three-way, 5,000X. It likely closes a position opened on 5/24 for 61 cents when AET was about 20 cents below current levels. They’re probably taking small profits on the three-way now rather than running the risk of holding a bullish position in the name ahead of Obamacare ruling from the high court.

Implied Volatility Mover

CBOE Volatility Index (.VIX) is off .56 to 17.76 and falling to its lowest levels since May 8 as the S&P 500 rallies 12.75 points to 1,357.53 (through the first hour). Overall options volume is running about the typical levels. 2.3 million calls and 1.9 million puts traded across all the exchanges in the first hour. Trading in the VIX pit is busy ahead of the expiration. It’s the last day to trade June contracts before the settlement value is computed tomorrow morning. 185,000 calls and 146,000 puts traded on the index so far. Of that, about 195,000 contracts, or 59%, are front-month June contracts. Open interest in the June term is about 1.6 million calls and 1 million puts. Astonishingly, with VIX below 18, only 5,700 VIX June calls, or less than .4% of the total OI are in-the-money heading into expiration. More than 80% of the puts are ITM and nearly 70% of the total Open Interest in VIX options are out-of-the-money. Yet, the fact that a lions share of June upside calls are set to expire worthless, doesn’t seem to be deterring new positions in upside calls on the product. One of the top trades in VIX Tuesday is a July 30 - 40 call spread, bought for 52 cents, 20,000X.

Unusual Volume Movers

Bearish activity detected in Eagle Bulk Shipping (NASDAQ:EGLE), with 2,496 puts trading, or 3x the recent average daily put volume in the name.

Bearish activity detected in Harvest Natural Resources (NYSE:HNR), with 6,510 puts trading, or 26x the recent average daily put volume in the name.

Bearish activity detected in Check Point Software Technologies (NASDAQ:CHKP), with 2014 puts trading, or 5x the recent average daily put volume in the name.

High options volume is being seen in Arena Pharmaceuticals (NASDAQ:ARNA), J.C. Penney (NYSE:JCP) and Oracle (NYSE:ORCL).

Source: Tuesday Options Recap