Friday Options Recap

by: Frederic Ruffy


Poor economic data in Europe, including slumping German exports and declining French business confidence, helped set the table for an increase in risk perceptions Friday morning. As EUR/USD lost about 1% and made a run back toward 1.24, VIX ticked to a morning high of 23.1. Yet, stock market averages held steady early and the S&P is now up 1.6 points. VIX is down .35 to 21.37 and 7.5% off session highs amid light volumes in the options market. 2.7 million calls and 2.7 million puts in the first two hours, which is about 75% the daily average. With a light economic calendar until Wednesday’s retail sales numbers, volumes are likely to slow even further today ahead of the weekend. Indeed, the tone of trading is much different than just one week ago, when the S&P 500 suffered a 32.2 point loss on June 1. The S&P 500 has since recovered the entire loss and is on pace for its best weekly gain for 2012. VIX is on a five-day 20% losing streak on the week.

Bullish Flow

Facebook (NASDAQ:FB) options were seeing heavy volume this morning, with more than 100K contracts trading in the first hour, putting the product on track for a potential new record over 400K contracts. The stock was up 4% and the order flow appears directionally bullish.

The activity included a large ratio call spread trading in which a customer bought 10,000 June 29 calls to sell 20,000 June 31 calls for a 17.5 cent debit. The spread seems to be a short-term bet on a move to $31, or 13.2% advance through the end of next week. At $31, the 29 calls are worth $2 and and the $31 calls expire worthless. The debit is at risk if FB holds below $29 and the position is left open through the expiration. There is additional risk to the upside, because not all of the 31 calls (which are sold) are covered by the 29 calls, that were bought.

Since options were listed on May 29th, more than 2 million contracts have traded and open interest is grown to 915,000 contracts, with nearly 50% of the open interest in the June and July terms. There is very little OI in the longer-term contracts and that might reflect the uncertainty that investors face related to the longer-term outlook for the company’s earnings and share price.

Bearish Flow

A bold trade is being initiated in the SPDR Financials (NYSEARCA:XLF) today. Shares are up 6 cents to $14.03 and have rallied 5% since Monday. One player in the options market seems to be anticipating additional volatility in the banks and brokers. 20,000 July 14 straddles were bought on the ETF for $1.09 per straddle. More than 45,000 have traded on the session - making the July 14 puts and calls on XLF among the most active options today.

If it’s an opening play (and it might be closing), the straddle buyer is anticipating a substantial move higher or lower in the financials over the next six weeks. In this strategy, the investor bought July 14 puts on XLF for 61 cents per contract and bought July 14 calls for 48 cents. The total premium purchase is $1.09. The breakeven of a straddle at expiration is always the strike price plus and minus the debit. In this case, the breakevens are $12.91 and $15.09, or 7.5% below and 8.2 percent above the current spot price.

It’s a bold trade because of time decay. Both of the puts and calls will be losing value due to time decay (vega), with the entire debit at risk if shares settle around current levels. At $14 in 42 days, both the puts and calls expire worthless and the debit is lost. On 20,000 straddles for $1.09, the total premium is $2.2 million.

Implied Volatility Mover

Implied volatility is another important consideration when buying a straddle. 30-day at-the-money implied volatility in XLF is up .5 to 27.5 and roughly midway between the 2012 high and low of 34.5 (Monday) and 18.5 (3/26). The straddle buyer benefits if implied volatility moves higher. Falling IV hurts the position. The key to success when buying straddles is for the magnitude of the move (delta) in the underlying stock, ETF, index or futures contract to be sufficient enough to offset the negative impact of time decay. It doesn’t matter if the move is higher or lower. Changes in IV can help or hurt the straddle buyer.

Unusual Volume Movers

Bearish activity detected in FactSet Research Systems (NYSE:FDS), with 2082 puts trading, or 14x the recent average daily put volume in the name.

Bullish flow detected in Family Dollar Stores (NYSE:FDO), with 2147 calls trading, or 6x the recent average daily call volume in the name.

Bullish flow detected in Sony (NYSE:SNE), with 6541 calls trading, or 8x the recent average daily call volume in the name.

High options volume is being seen today in Wells Fargo (NYSE:WFC), Yum Brands (NYSE:YUM) and SPDR Homebuilder Trust (NYSEARCA:XHB).