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Daily Options Intelligence Report

Volatility creeps higher on Wall Street as investors chew over data

Tue, Oct 27 2009, 18:37 GMT
by Andrew Wilkinson

Interactive Brokers LLC  |  View company's profile

VIX – CBOE Volatility index – Monday’s leap in the reading of Wall Street’s fear gauge was accompanied by one of those occasions when investors were left flat-footed during the trading day as stocks flashed from green to red. It was highly reminiscent of the trading pattern in 2008 and earlier this year when, try as they might, investors couldn’t shake off the recession blues no matter how economists tried to spin data points. Monday’s 10% rise in the Vix has been followed today by a further 0.5% rise to 24.43 only one week after the market volatility reading tried to dip below 20, effectively wiping risk aversion off the radar altogether. Today, however, one option investor appears to be looking for a substantial return to volatile sessions and sold at-the-money put options to back his bet that the Vix will return to a mid-30 reading by the end of 2009. Some 24,000 call options at the 35 strike were bought for 79 cents, partially funded by the sale of almost 7,500 put options expiring at the same time for a higher 1.90 premium. One possible explanation for the actions of this investor, who expects the value of the puts to fall and the price of the calls to increase, is Tuesday’s return to deteriorating consumer confidence. With more than two-thirds of output origination from consumers, this trader is concerned about further market weakness ahead.

XHB – SPDR S&P Homebuilders ETF – Positive news regarding U.S. home prices may have inspired one investor to initiate a long butterfly spread in the November contract. Shares of the homebuilders exchange-traded fund are relatively flat at $14.80. The S&P/Case-Shiller home-price index gained 1% from the previous month and the number of U.S. building permits issued in the month of September was revised up to 0.575 million units from previous estimates of 0.573 million units. Economic data aside, the butterfly spread initiated this morning is a bullish sign for the XHB. The butterfly was constructed through the purchase of 10,000 calls at the November 15 strike for 54 cents each [wing 1], and the purchase of 10,000 calls at the higher November 17 strike for 8 pennies apiece [wing 2]. The central November 16 strike had 20,000 calls sold for 21 cents per contract [body]. The net cost of the transaction amounts to 20 cents per contract. The nature of the butterfly strategy indicates the investor expects shares to settle at $16.00 by expiration next month. Shares must rise approximately 8% from the current price to $16.00 in order for the trader to reel in maximum gains of 80 cents per contract. The parameters of the trade are such that the investor may lose no more than 20 cents – the cost of the spread – but stands to gain 80 cents. The investor has wisely devised a strategy with a risk-reward ratio of 1-to-4.


XRX – Xerox Corp. – Option bulls trampled the December contract for Xerox calls despite the 0.75% decline in shares to $7.71. The purchase of about 15,400 calls at the December 9.0 strike for 15 cents apiece suggests investors expect shares of XRX to rebound by the end of 2009. Call-buyers at this strike will profit by expiration if shares rally approximately 19% to surpass the breakeven point at $9.15. The rise in demand for calls has perhaps contributed to the 10% rise in option implied volatility on the stock to the current reading of 43%.


EFA – iShares MSCI EAFE Index ETF – Shares of the exchange-traded fund representing stocks from Europe, Australasia and the Far East, edged slightly higher today by less than 0.25% to $55.40. We observed bearish activity in the near-term November contract despite modest gains in EFA shares. It appears one investor established a ratio put spread by purchasing 5,000 puts at the November 55 strike for an average premium of 1.33 apiece, and by selling 10,000 puts at the lower November 50 strike for 25 cents each. The net cost of the pessimistic play amounts to 83 cents per contract. The transaction is likely the work of an investor holding a long position in the underlying stock. If this is the case, the trader purchased downside protection that will kick in if shares decline beneath the breakeven point at $54.17 by November’s expiration day.

 

Published on  Tue, Oct 27 2009, 18:39 GMT