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After two weeks of holiday interrupted, low volume trading, the US equities markets got back on a regular schedule yesterday and it looks as though the weakness could be with us for some time for fundamental, technical, and geo-political reasons. With the dollar at historic lows, energy at historic highs, top lending institutions denying rumors of bankruptcy, and the always uncertain status of US diplomatic relations in oil producing areas, it would be very difficult for even the most steadfast contrarian to engage in a bullish argument here. One caveat that I will add to that statement, however, is that the largest positive price movement days usually occur during primary downtrends so don’t be surprised to see a day where the INDU adds 400 and the COMPX gains 100.

But the general gloomy scenario continues to loom, and it is difficult to avoid reference to the dirty word of “stagflation” especially since it recently was on the omniscient lips of former Federal Reserve Chairman Greenspan. Crude oil briefly touched $100 per barrel twice last week before retreating to slightly over $95 per barrel yesterday, which is, depending on calculation method, just about on par with inflation adjusted all time highs of the early 1980’s. Add to that the compounding data that is pointing directly at an economic contraction cycle, and it would seem that additional downside is waiting in the wings, regardless of the smoke and mirrors that is being used to manipulate the global liquidity situation.

Of course anyone who is an Options University/Options University Strategist student or subscriber would have been prepared for this downside by being properly hedged and completely expectant of the movement that we have seen. But the beat goes on, and last week was a very interesting one as it pertained to the manner in which the markets digested macroeconomic data. For quite some time, recessionary data had been construed by the markets as buying stimulus, simply for the fact that it would undoubtedly cause the FOMC to ease monetary policy and therefore prop up the markets, artificially in my opinion. However, beginning with two events last week, the ISM index on Wednesday, and the employment report on Friday, that paradigm has begun to change. Both numbers came in below market expectations quite significantly to add to the recessionary case. However, after each report, instead of rallying in hopes of further cuts, the markets tanked quite drastically. And with the fed fund futures seemingly pricing in another 50 bp cut at the Jan 29 meeting, the subtle recessionary news released by AT&T and CFC today, resulted in a nearly 300 pt. tailspin in the INDU.

Technically, all three major indices have closed below the November lows, and the SPX closed today below its 500 day simple moving average. Moreover, after finding obvious, although temporary, support at several Fibonacci retracement levels from the March low to the October high, the only level left is the 100% for the SPX and that would bring us to 1364. As foretold by the staff at OU, the VIX reverted to its mean from the December 24 low, coincidentally at the 200 day sma, to add almost 38% in two weeks. There are a lot of ways to make money in these markets, but only if you are educated enough to take advantage of the opportunities.

Gregory Wolfe
The Options University

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It appears as if the Federal Open Markets Committee will once again play Superman to the Lois Lane that is the US equities markets. The scary/recessionary macro economic reports and subsequent announcements by Fed chairman Bernanke and his second in command last week appeared to have erased all doubts of the expected December 11 rate cut, and replaced the level headed bearish theme of the last couple of weeks with the “band-aid on a melanoma” bulls who are addicted to interest rate cuts like heroin junkies. They know that a quick fix will provide short term relief, but it is just another step on the way to inevitable disaster.

The 1,000 plus points that the DJIA gave up since the last meeting, and similar sell offs in the other major averages, were due, mostly, to the wire that the fed was walking between the weakened dollar/outrageous energy and commodity prices and the expected fallout from the sub prime lending disaster. This led to, as related in the minutes from the Oct. 31st meeting that were released last Monday, to a “close call” between a cut and a status quo at that particular meeting, while most of the recent bull run was already pricing in a December cut.. However recent dovish data has once again enlivened the bulls and the Dow added 390 pts last week to close at 13,371. The S&P 500 index followed suit to close the week up 40 pts. To 1481, while the NASDAQ completed the trifecta with a net gain of 64 to close the week at 2660. Add to this a sell off in oil in excess of $10 for the week to close at a dirt cheap $88.71, and the S&P finding 78% Fibonacci retracement support at 1409, and you have at the very least an excuse for short covering and profit taking by the bears, if not new bullish positions being instilled by the junkies.

Although breadth was also bullish last week with advancers leading decliners on the NYSE by a margin of 2630 to 930, there were 605 stocks that found new lows while only 144 reached new highs. As we languish fundamentally between true recession and the lure of cheaper money, and technically as all averages toe their 200 day sma, indecision will continue to be the theme. In the week ahead, it would be safe to assume that anything that would give the fed more comfort in a 50 bp cut (i.e. recessionary data, England easing their interest rates on Thursday) will lead to fervent buying, and a scenario more tepid could lead to some selling. However, with implied volatilities still relatively low in the options markets, there are many ways to be profitable here. It also should be taken into account that the anticipation of the cut has recently led to the buying while the activity subsequent to the cuts has been the selling off.

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November 4, 2007

I honestly don’t know when this madness will end, and the US equities will just take their 25% correction like a man.  Last week, the FOMC, as expected, cut both the fed funds and discount rate another 25 basis points, but also finally made some not quite subtle comments regarding the stifling energy and commodities prices that are being precipitated, at least in part, by the continuing devaluation of the US dollar.  Although the markets rallied on this news, the bill was paid the next day in the form of a near 400 point drop in the DOW, even after over $40 billion of liquidity was pumped into the system on that day.  The fallout from the irresponsible lending and borrowing continues as Citigroup’s CEO Chuck Prince seemingly will follow the lead of Merrill Lynch’s Stan O’Neal and take his formidable severance package and quietly sneak out the back door.

The stock gave up nearly $5 on Thursday and Friday to close at $37.73.

My assessment of the week from a fundamental standpoint was that most of the data was stronger than expected, oil closed at a ridiculous $95.93, and the dollar is at all time lows versus basically every  other currency.  The whispers of a pause, if not a hike, will shake these markets further, because the additional 25 basis point cut that is expected on December 11, which I alluded to in earlier articles, might not take place and the technical dynamics of the major averages are having very difficult times with these toppy levels.

However, the VIX remains curiously low (went out at 23.01 on Friday), and downside protection will be cheap to come by.  As a matter of fact, it is this author’s opinion that the time to get long the dollar could be right around the corner, and of course that would lead one to be short equities, energy, and commodities and long the VIX.  Although, that is predicated on the fact that the folks in Washington remember that it “is not the job of the FOMC to bail out the US equities markets”.

From an options standpoint, cheap volatility and substantial intraday price swings would lead most traders to consider long gamma positions, this strategy would been appropriate in the recent past.  For an explanation of this strategy, go to www.optionsuniversity.com.  In addition, subscribers to our membership site would have been made aware of a possible short term price reversal in MRK, based on a technical scenario called price/volume divergence.  From Wednesday’s close to Friday’s close, MRK was down over $2, with very little in the way of extrinsic price in the Nov 60 puts.  I would tend to expect some short term sideways activity forthcoming with little in the way of data or earnings to be expected.  However, geopolitical activity is always on the radar, as is now perhaps some more resignations in the financial sector???

 
Greg Wolfe, Options University

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Well I think that the one word that could best describe the activity of the US equities markets last week would be indecision.  We appear to have landed in a sideways market, subsequent to the major indices reaching new highs and now consolidating, albeit in quite violent intraday fashion.  The bulls and bears are locked in an impressive battle that is the result of both technical and fundamental factors, and we may not see a true breech or retreat from these levels until the next FOMC meeting, unless the forthcoming earnings data is both dramatic and broad based in either direction.

Fundamentally speaking, the bulls appear to be a little bit uneasy about their additional 50 basis points cut that most expected to be a sure thing before the end of the year.  Slightly stronger than expected data in the weekly jobs report and retail sales and PPI numbers point to a possibility that the much feared recessionary boogey man could be avoided.  Add to that the rumblings from Europe that their central bank may be prepared to hike, and that may lead one to believe that the beleaguered dollar cannot be devalued further.  A “stand pat” or god forbid a hike by the fed, could lead to a quite impressive sell off.  Lookout this week for CPI numbers for September and housing starts and new permits from September.  Both of these numbers will be released on Wednesday  

Technically the Dow ended the week up a meager 28 points for the week although there were several days of tremendous volatility, and the index closed above the very important level of 14,020, although not decisively enough for me to turn bull nor was it on impressive volume.  Looking to the SPY, the sell off that occurred on Thursday was on almost twice the volume that the rally days of the week had.  Energy and commodities continue to soar, and earnings are looming.  Monday, Citigroup will report before the bell with 44 cents per share expected, and Intel will report after the bell on Tuesday with an expectation of 30 cents per share.

In a market environment like this, with cheap volatility and violent intraday swings, the long gamma trading strategy can be quite profitable if the trader is vigilant.  A trader can use his gamma position(by purchasing options) to flip stock throughout the day and not have to exceed much in the way of his short theta (decay), because the price he paid for that gamma is relatively cheap.

There are two things one might consider going into this week.  First, will the devalued dollar serve to enable company earnings to be over inflated and therefore exceed expectations?  Secondly, E-Trade Corp. reports earnings after the close on Wednesday.  If they soundly exceed expectations, could that lead one to believe that more retail long players are entering the market, leading one to believe that we may be looking at the top in US equities?  Or would we be better off to continue to be indecisive?
 

Gregory Wolfe

The Options University

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Today’stickers: BIDU, VIX, JWN, SII, F, GM, WMT, NRG, GSF, GOOG

BIDU – When Confucius said that a journey of a thousand miles starts with a single step, he didn’t know he was likely referring to the share price performance of Chinese Internet search-engine Baidu.com. Just one year ago the shares could be bought for less than $100 each and until today the march upwards has met with only a tiny degree of resistance. Shares traded at a record high this morning above $350. the company has been likened to Google, with the added boost that the company operates in China, where replication of just half of the success that Google has had, will lead to a phenomenal performance for Baidu. However, today’s revenue forecast reduction from a JP Morgan analyst sent shares into a tailspin quickly losing 10% of its value. The latest 65% EPS growth and all of the opportunity that the company promises in Asia has left the company sitting on a PE ratio of 156 times. JP Morgan only reduced its revenue forecast by 3.2% to $65.7 million but perhaps the episode serves to remind investors that Baidu revenues don’t compare to those of Google and that no matter how attractive Asian markets might appear, investors need to understand the size and profitability of the companies they are investing in. Today’s move weighed heavily across the market and turned a positive day into a key reversal with many markets reaching record heights before closing lower on this side of the Atlantic. This might upset the cozy applecart in the fourth quarter where investors were beginning to overlook the low bar set for minimal earnings growth.

The downgrade sparked heavy options trading on Baidu. There was heavy selling in the October call at the 350 strike, which was the most heavily traded series today. More than 700 calls traded to the bid at a premium of around 17.0. Earlier in the session, the same calls were traded at premiums in excess of 20.0 and during the fallout lost as much as 75% of their value trading at 4.5. In the November contract put buyers emerged on decent volume as low as the 280 strike indicating a fear that Baidu shares may fall further in coming sessions. Options implied volatility jumped 21% to stand at 91% late in the session as options traders were caught on the hop with the oversized reaction to the news. The historical movement on the share price is around half of today’s closing options volatility.

VIX futures surged late in the session as the stock market turned southwards reversing a triple-digit Dow industrials gain and turning into a 69 point loss. As such investors reached for portfolio insurance and bought VIX futures driving the index up from a loss on the day to a 13% gain to close at 18.94. Heavy volume was apparent in the November strikes at the 22.5 and 25 contracts where premiums rose by around one half this afternoon.

JWN – Bearer of bad retail tidings, department store chain Nordstrom cropped its Q3 profit forecast due to weak sales growth and stagnant inventories. Shares are currently trading 6.5% lower at $45.41, 12% below its average share price for the year to date. A look at today’s option action shows traders bearing little confidence that Nordstrom can pull off a substantial recovery even after the holiday shopping season. Some of the volume in the January contract looks like it may be deployed in call spreads, involving the purchase of the 45 calls, funded by the sale of the same month’s calls at the 50 strike. A look at the delta on the 45 calls shows option traders pricing in better than 50/50 chance of that strike being profitable by expiry. By comparison, the 50 strike has only about a one-in-three chance of landing safely in the money. To put Nordstrom’s current woes in perspective, last winter’s sales took Nordstrom shares within range of $60 – its standing 52-week high of $59.70 was set back on February 22.

GSF – Offshire oil driller GlobalSantaFe, which operates a fleet of 61 marine drilling rigs, is trading 2% higher today at $79.30, and the options market is rife with bullish speculation in the company. Options are trading at 28 times the average volume, with the 76,000 active contracts matching about a fifth of prior open option positions in Global Santa Fe. Today’s volume is split between the October 80 and November 85 calls, which have traded to buyers on sharply higher premiums, as traders wager on a move past the standing 52-week high of $80.34 by mid-November.

SII – Fellow oil services ticker Smith International, the producer of small hardware for the oil and gas exploratory and production sectors, is also revelling in a 1.5% gain in shares to $74.76. Options are moving at 10 times the normal level, with trading in calls and puts picking up sharply today, on no apparent news catalyst. The brisk buying in the October 80 and November 85 calls, implying continued upside tear in the next two months, is given particular gravitas when you consider that Smith’s prices have more than doubled in value this year. Today’s share price represents a fresh 52-week high. Implied volatility has remained mostly steady since late August.

F - Yesterday’s 6-hour walkout by Chrysler auto workers under the banner of the UAW was mercifully brief thanks to an accord that will create a union-run medical fund for Chrysler workers, but without the rub of future job guarantees like those wangled from talks frontunner GM. The agreement raised prospects that a strikeless settlement can be reached with tertiary target Ford, generally regarded as the weak link of the three auto makers – the one with the shallowest pockets for concessions and with the greatest potential damage effect from a strike. Ford shares responded buoyantly to the news, gaining 5.6% to $8.69. Volume appears clustered in the November and December contract, where traders wrote November 9.0 calls in fresh positioning, against the purchase of November 8.0 puts. The strategy was reversed in the December contract, where December 9.0 calls were bought against the sale of puts at the 7.0 strike level.

GM – Meanwhile, shares in Ford peer General Motors bounded to a two-year high today, up 5% to stand just above $40 after UAW members ratified the terms of its recent collective bargain agreement. Option traders put more than 308,000 contracts in play, plowing into the October 40 calls, which were heavily bought. The same strike in the November contract attracted buyers and sellers, as the price of the November 40 call doubled in price today. While overall open interest shows investors still defensively positioned in GM options, with puts outweighing calls by a factor of 1.8, today’s volume is an indication of some traders betting on a return of GM shares to 2004 levels.

WMT – This morning’s rise in September same-store sales and upscaling of Q3 earnings guidance were a welcome revelation to investors weary of sifting through the jumble-sale prospects of leading retailers. Just a couple of months ago the big-box chain was sounding the alarm over the pinched state of the American discount consumer. The news sent shares 3% higher to $47.00 today, with more than 102,000 option contracts in play. A look at options action shows traders less inclined to jump on the directional bandwagon and likelier to take profits. Twice as many calls are moving as puts today, with heavy selling in the November 47.50 calls, where premiums increased 100% overnight. The urge to close out call positions extended into the December contract at the 50 strike, where premiums are up 62% today.

NRG – Shares are currently 1.6% higher at $44.39, having been up as much as 4% early in the session, sending options traders on a quest for bull plays. With options trading at more than 5 and a half times the average volume, call buyers are plying into the 45 and 50 calls in the October, November and December contracts on sharply higher premiums. Implied volatility, at 40% and rising, also shows a keen elevation from the 25% historical reading. NSF reports earnings on October 29.

GOOG – The enchanted search engine continues to cast a spell over market bulls, but early gains have turned flat this afternoon, as the ticker trades at $624.04 this afternoon. Option players activated more than 211,000 contracts this afternoon, with a volume bias to calls. The upward trek was accompanied by implied volatility – which took a 12% leap this morning, 1 week ahead of earnings. Today’s activity is a call flurry in the front month contract at strikes of 620 to 650, with builds at the 750 strike seen in October and November after a fresh wave of punditry betting on Google “trigger-numbers” inthe $735-750 range.

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Well, there is an old axiom that says something like “a sane man who dwells in a society of the insane, will then appear insane himself”.  This paraphrasing is, I am sure, words that ring very true to market bears that find themselves scratching their heads after yet another decisive rally on Wall Street on Friday, based apparently on nothing but a tepidly favorable September employment report (does a few thousand extra service and government jobs signal an economy that is not ripe for a recession?).  However, relating once again to my previous quote, it is the crowd that moves markets, and sometimes being intrinsically “right” in a market that is “wrong” can make your portfolio become anemic with sound logic as the perpetrator.  There are many people with tremendous market savvy who have become broke based on their inability to abandon their own correct and sometimes precocious logic.

Having said that,  I personally cannot see much of a case for the health of a market where the basic prescribed key to rescue the economy is to cheapen the dollar, print more money and encourage Americans to purchase and consume things that they cannot afford that were bought from other countries that employ slave laborers.  I guess it’s easy to see that I am a little bearish on equities here.  I also would like someone to explain to me how it is now being proposed that these “strong employment numbers” that indicate  “healthy economy”  will now make the 50 basis point cuts that were basically priced in for the next two FOMC meetings now unnecessary.  Will that be bullish as well?  Not to mention the enormous draw downs by several large financial institutions, which was brought on by the still to be determined damage by the credit crisis and reckless loaning/borrowing.  In addition, we also must deal with the constant specter of outlandishly priced energy and commodities.

Earnings season is upon us, and with the expected aggregate numbers to be much lower than previously expected (according to the analysts), one would expect some warnings to be forthcoming.  The DOW did sell off quite significantly in the last hour of trading on Friday, which could be somewhat comforting for the bears.  However, after the close, previous month’s employment numbers were revised to show stronger data.  I guess someone saw what a few extra jobs in Sep. could do to the market and then decided that better numbers from the last two months could give us even more upside.

Technically, it is obvious that the markets are having a difficult time with these levels, and while I predicted last week that we would find the all time high imminently, I also said that I believe consolidation will occur for quite a while at these levels.  With the VIX down 1.53 for the week to close at 16.91, I feel fairly comfortable that will be the case.  That would mean a concentration on selling premium such as buy-writes, short iron condors/butterflies, long condors/butterflies, long time spreads, and vertical spreads with short at the money options.  I personally use a 3% false violation parameter when considering a move to be a violation of resistance, especially in the indices, and we are quite a way from there.  But still the question remains. Is bad news good or bad news bad?  Fighting the tape is a lonely place regardless.

Gregory Wolfe

The Options University

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Today’s tickers: SLM, WAG, GRMN, RIO, FCX, NEM, AA, MFE, PDLI, CREE & CBH

SLM - News today that an investment consortium led by J.C. Flowers and including Bank of America and JP Morgan Chase would offer $50 per share for Sallie Mae (SLM) in combination with warrants for outstanding shares, sent the company’s fortunes up .34% this afternoon to $50.07. A post-deal analysis in the Wall Street Journal noted that these warrants – pending Sallie Mae’s business performance going forward – could be worth up to $10 per share, creating the impression that J.C. Flowers’ original $60-per-share offer (a price from which the buyers balked last week) is still nominally intact. Option traders put more than 132,000 Sallie Mae options in play, with calls and puts trading at near parity – but virtually no one staking bets on that elusive $60 mark. The October 50 strike appeared to be the watermark for today’s activity. The 30,000 lot-volume in the October 50 calls looks to have been generated by sellers, unloading for $2.40 positions that were bought at prices of $1.20-1.85 last week. Puts at the same strike in the October contract traded to buyers and sellers. We also noted heavy liquidity in the November 50 calls, which traded 13,600 times – open interest having tripled at this strike over the past week. Implied volatility has continued its decline, since topping out at 67% last Thursday, and now rests at 33%.

HSY – Shares in Hershey, the country’s biggest candy maker, were unsettled by this morning’s news of the departure at year’s end of CEO Richard Lenny, due to reported wrangling with the majority shareholding Hershey Trust over the company’s strategic direction. Implied volatility ticked up to 26% as a trader took the opportunity to enter a 9,000 position in the January 40/50 strangle. The position, which costs $1.20 to enter, supposes a break outside the range of the strike prices above $51.20 or below $38.80 in the wake of Lenny’s departure. Hershey’s share price has shown a mostly steady decline for the past 6 months since peaking at $56.75 in early April – the reigning 52-week high. The current share price is hovering just about $2 above the 52-week low set in August. Hershey’s shares were trading as high as the $60 mark in October 2005, but hasn’t touched those levels since.

GRMN - GPS-technology maker (GRMN) continues to captivate option traders’ attention in the wake of Nokia’s contentious bid for Navteq yesterday. Shares are extending the downtrend from yesterday, down 7% to $99.80, with 116,770 options – the rough equivalent of 42% of its open interest – in play. It appears that the October 100 calls are the pivot point for extensive volatility positioning in the October contract, some of this possibly tied up in the 100 straddle, a position which costs more than 10% of today’s share price to buy – or with strangles involving the 95 puts. Activity in the November contracts seems to show traders favoring a sale of calls at strikes 105 and 100.

WAG - Shares in Walgreen’s (WAG) tacked on another .40% loss today to stand at $40.00 – slightly off a new 52-week low set earlier today - while options remain a favorite target for option traders. The 87,760 options in play this afternoon reflect traders waging bets on the at-the-money front-month straddle, which has traded on comparable volume to buyers and sellers today.

There was a strong overnight performance for Asian equities with more stories surfacing that the $200 billion Chinese investment fund would buy Chinese stocks listed in Hong Kong. Local stocks rose by more than 3%. Elsewhere around the globe new record highs are being set by the day as investors buy the story that growth outside of the U.S. continues to steal the limelight from the overused terms of “subprime and credit concerns.” In Monday the price of gold (the anti-dollar) rose close to a 28-year high as the value of the dollar slumped to a secular low. The dollar boost was exacerbated following comments from European central bank members who noted the potential damage to the fragile domestic economy from a swift rise in the value of the euro.

But Tuesday is a different day. Investors in the local market are watching to see what reaction Monday’s convincing penetration of index highs will bring. So far some light profit taking is the order of the day. Meanwhile the dollar has bounced hard against the euro currency and its trade weighted value as measured by the NYBOT’s dollar index contract has risen by 0.5%. Broadly speaking that move is bad for commodities – we note that gold has shed 2.5% today to $728.50 per ounce in the October contract. Meanwhile, shares at several mining companies are facing selling pressures.

RIO – Cia Vale do Rio Doce saw its share price slide 2% to $35.35. It’s on days like this that options traders put a brave foot forward and take the opportunity to place bullish trades. The call/put ratio at 1.6 indicates one third more call activity than across the put complex. The bulk of Tuesday’s activity stood at the October 35 line where nearly 14,000 contracts changed hands reserving the right to buy shares at that price ahead of expiration in two weeks time. At a premium of 1.95 shares would need to break above $36.95 for option buyers to be profitable. The likelihood of these calls landing in the money according to the delta on the calls is three-in-four.

FCX – Freeport McMoRan shares fell in line with the rally in the dollar losing 2% to stand at $109.15. Again call buyers were out in force on the price decline and buyers of the November calls at the 105 strike took advantage of lower premium prices as they bought 2,900 lots. The October straddle at the 110 strike gives a good reading of implied volatility on the options. Today that straddle – the combined cost of a call and a put is 9.25 generating a share price range of between $101.25 and $119.25 over the coming couple of weeks. Actual implied volatility stands at 48%, which is in line with the historic reading of volatility on the underlying shares.

NEM – Newmont Mining Corp. saw its share price lose 2% to stand at $45.14 today, but unlike above, put buyers seemed to arrive on the scene. Implied volatility on the options at 33% shows that options players aren’t overly concerned by today’s push lower. In Monday’s session it appears that fresh positioning of 3,000 puts at the March 45 strike took place. Today it was the turn of the January series where 11,000 puts at the same 45 strike traded at 2.95. Such puts would protect a long investor in Newmont against share price declines below $42.05. Still the bulls wouldn’t be deterred and added call spreads in the October contract as they bought the 47 strike for 0.40 and sold the 50 calls for 0.10. At a net premium of 0.30 it’s a cheap play on a big rebound on the gold price, which investors would hope filters through dramatically to boost the fortunes at Newmont.

AA – Alcoa Inc. We noted some bull call positioning in Alcoa shares today even though its share price declined .77% to $38.85. In the January 47.5 contract some 2,200 calls were bought at 0.85 indicating that investors see a bounce ahead for the stock. In the April 40 puts a seller sold around 6,700 lots at around 4.4. That would indicate that they see shares moving higher. Don’t forget that Alcoa was left jilted at the altar when Rio Tinto stole the Canadian bride-to-be away from Alcan. Additional positioning in April calls at the same strike confirm the bullish profile. The logic seems to be that if commodity prices and demand both remain firm, there is no reason that the fortunes for Alcoa are as bad as was suggested by the share price decline following the failure to acquire its Canadian rival. Shares fell from close to $50 to almost $30 in the aftermath and the past few days performance suggests a revival is imminent.

MFE - The revival and swift propagation of M&A rumors suggesting a possible tie-up with Dell (DELL), coming one day after a major product announcement, has led to a rabid level of interest in options in tech security giant McAfee (MFE - $36.84). Implied volatility rose more than 18% on the session to stand at 43.11%, as options traded at 28 times the average rate. Of note was heavy buying in the October 40 calls, which were snatched up at $0.40 apiece. We also observed heavy liquidity in the November 40 calls. Traffic in each of these strikes appeared to be fresh positioning – i.e., not the closing out of previously open positions. McAfee shares have shown a gradual but consistent incline over the past year, up 48.5% during the past year, handily outperforming the S&P Midcap Index, of which the company is a component. Yesterday McAfee formally announced that it was first-to-market in unveiling an industry standard “triple play” security offering on the IT market, providing protection for consumer PC, web and mobile phones.

PDLI - Following yesterday’s executive announcement that PDL Pharmaceuticals (PDLI) – maker of drugs for hypertension, acute myocardial infection and leukemia - will seek to sell the entire company, option traders rejoindered in the affirmative… and in trend with a near-9% gain for shares to $23.28. Traders today put more than 56,000 contracts in action – matching about 20% of its total open interest, and 5 times the normal level. Today’s volume was skewed to the calls, where three-figure percentage increases in call premiums were indicative of much of the action. Volume appeared heaviest at strikes 22.50 in the October and November contracts, while volume of 1,000 lots has gone through in the October 25 calls and the November calls. Traders here appear to be positioning for a test of the previous 52-week high of $27.98. Meanwhile, implied volatility in PDL shares surged about 18% to 49% - still below the 69% volatility that its shares have shown historically.

CREE - Options activity in North Carolina-based semiconductor maker Cree Corp (CREE) piqued our volume scanners today, with nearly 26,000 contracts in play against a 2% gain for shares to $32.72. The stock has been the subject of previous takeover scuttle, but as yet all the talk has failed to give form to the fog. Earlier today we observed heavy liquidity on either side of the October 30 and 35 strikes, with premiums favoring the call side. The calls, it seems, sold to the bid, while the puts traded to the middle of the market. Note here that the price of the October 35 straddle is $4.25 – 12% of the share price, and indicative of a traditionally volatile stock. While option traders are factoring in 60% volatility, Cree is a stock that has shown more than a 57% degree of fluctuation historically. And as for the October 35 call strike – delta on this call shows option traders pricing in about a 40% chance that this strike will land in the money, placing Cree on the perch of a new 52-week high, by October expiry.

CBH - Following this morning’s news of a buyout by Canada’s TD Bank Financial Group - options in Jersey-based Commerce Bancorp (CBH) picked up to twice the average clip, as shares traded flat-to-lower at $39.47. The 20,000 contracts in play matched more than 10% of Commerce Bank’s prior open interest. Today’s volume appeared hemmed in the front month, where traders may have sought to avail themselves of a 50% overnight drop in implied volatility by selling the October 37.50/40 strangle. This same sharp retreat in implied volatility made short order of yesterday’s build in open interest in the October 42.50 calls. Possibly acting on a rumor on the eve of TD’s bid, traders sent open interest on the October 42.50 from a meager 735 contracts to nearly 4,370 at closing bell, with contracts commanding $0.55 apiece. After TD’s $42-per-share bid, those $42.50 calls plummeted in value to only about a dime apiece, and traders may have closed those positions out this morning. This is also a hint that the market believes Commerce Bank’s shares are fairly valued by TD, owing to the anticipated dilution in earnings following the deal.

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Today’s tickers: HLF, CVS, AKS, GRMN, WAG, C, RIO, NVT & EWH

WAG – Walgreens share price took a smack on the chin despite a bullish start to the week. The near-15% slump in its shares created a fertile battleground for options traders thanks to the presence of liquidity and volatility. The company announced a 4% decline in quarterly profits thanks to a nasty combination of rising wage costs, store expenses and lower reimbursements for generic drugs. That potent potion is precisely why the stock is being punished today. None of the inputs are necessarily one off problems for the quarter and looking forward investors will need to see precisely what strategic shifts management makes to address the concerns.

Around 135,600 options contracts were in circulation Monday or put in an alternative context that’s about 67% of the overall open interest in the options series. Implied volatility surged by around one-third as uncertainty returned to the direction for the stock. Volatility jumped to 27.5%. Shares in Walgreens, which haven’t traded below $43 this year, fell to $40.31 - a 52-week low. October call options prices slumped with calls at the 40 strike losing 83% of its value to 1.25. On the other side of the coin put values surged. The October 42.5 calls for example, having settled at just a nickel on Friday, were actively traded at prices as high as $2.80 today.

It does appear that some investors are betting on steeper declines looking forward or simply betting that this might need a stronger prescription from management. There seems to have been a heavy amount of call option selling in the January 40 calls, where several blocks of 500 contracts were sold to the bid. Premiums slipped from 3.5 to 2.5 during the morning on volume of 11,650 lots.

CVS – Arch-rival CVS/Caremark came out shortly after the Walgreens release to reiterate its profit guidance for the year, but that didn’t stop a 6% pummeling-by-proxy for its shares on the market. With 95,000-plus option contracts trading this afternoon, we observed what may have been call holders looking to unload positions at the November 40 strike as premiums eroded, with volume at the 37.50 strike trading to buyers and sellers. Given the comparably heavy volume, and distribution of buyers and sellers, on the other side of that strike on the puts, it seems conceivable that today’s play is the at-the-money November straddle. A buyer of this strike pays the $2.75 premium in the belief that – whether CVS/Caremark’s profit guidance stocks – its shares are set for tumult in the coming weeks. A seller would take comfort in last week’s bank upgrade, and the fact that shares are still within 5% of a 52-week high, and play against short-term sniffles for the stock, pocketing the premium for good measure.

HLF –Options activity in nutritional supplement maker Herbalife ticked our volume scanners today as shares settled on a new 52-week high of $45.74. But despite short term bull momentum for the stock, it appears that skittish option traders holding Herbalife stock may have sought to hedge their bets on the mid-term outlook by playing the November collar. This would have involved buying the 40 puts at today’s premium of $1.05 against the sale of calls at the November 50 strike at $0.90 apiece in hopes of protecting against a sudden drop in share price below the $39.85 mark by November’s expiry. Overall open interest in Herbalife shows a surprising balance of outstanding puts and calls, with puts narrowly outnumbering calls by a factor of 1.1. Significantly, much of this build in puts accumulated during the month of September.

C – Citigroup Inc. shares reacted positively to its forewarning of a 60% dip in quarterly profits earlier today and losses incurred to its exposure to subprime debt. Investors seem to have taken the confession with a huge sigh of relief and bought stock, perhaps in the hope that this is the bloodletting that people have demanded to see. Shares have recently held at the $45 support line. Implied volatility came off while put premiums at the 45 line sank by around one half. Shares in the bank gained 2.2% to stand at $47.70. The December calls at the 50 strike reflected optimism by investors as premium rose by one-third to 1.0. Shares slipped below $50 in late July and haven’t recovered since. The 50 line was the most active call line in today’s trade. In the March contract it looks as though a couple of thousand puts at the 42.5 line may have been sold against call purchases at the 50 and 55 lines.

RIO – Cia Vale do Rio Doce – Commodity companies shares remained an investor favorite given the solid case afforded to them by the combination of a weakening dollar and strong commodity demand. Shares in Brazilian copper miner Vale rallied 6.5% Monday to stand at $36.15. Premiums at the October 35 and 37.5 calls jumped by around one half on heavy volume. Strongest volume occurred at the January 32.5 strike in the put side where some 13,500 contracts traded. As the stock rallied premiums came off, but this looks more like put selling rather than buying indicating continued conviction in a rally in shares.

AKS – AK Steel Holdings piqued our volume scanners today with nearly 127,000 active contracts against open interest of just about 335,000. Interested by the modest, half-percent gain in shares to $44.88, it appears that a trader closed out a position involving 24,000 lots in the October 35 puts in favor of new positioning in the November 40 puts, which traded on inflated premiums of around $1.90. AK Steel is due to report Q3 earnings on October 23.

NVT – Navteq Corp. Options activity at nearly 60,000 comprised exceeded the previous overall options open interest. Despite news that handset maker Nokia would buy the navigation software maker, shares took a 2% shave in early trading and sustained the loss this afternoon. The deal agreement sent implied volatility sharper lower and undermined any bullish positioning in the call options. For example, October calls at the 80 strike trading at 0.40 lost 85% of their value today.

GRMN – While news of Nokia’s acquisition was – somewhat counter-intuitively – bad news for Navtech’s share price, it was even worse for Navtech crosstown rival Garmin Ltd., whose shares swan-dived 10% to $107.25. Implied volatility shot up to 60%, having remained stable at 50% for much of September – a phenomenon that has borne out in put-side premiums today. Today’s 116,000 active option contracts show volume actively dispersed throughout the October contract, particularly concentrated between strikes 110 and 115 in both calls and puts. This is a strong hint of traders looking to position for continued volatility in Garmin share prices in the coming weeks. An interesting note about those October 100 calls, which traded 10,000 times today at prices around $9.80 – the going price for this contract last Thursday was $21.80. Ouch!

EWH - iShares MSCI Hong Kong - Shares jumped 1.8% today to rise to $21.42. Options activity was a robust 44,600 contracts - equivalent to around one-half of current open interest on the shares. The December 18 and 20 calls have traded on volume of 20,000 contracts each on prices of 0.30 and 0.75. It could be that as shares have ratcheted higher, an investor has rolled up the strike to remain closer to the current share price. Shares have been on a tear over the last six weeks adding around one third as the Pacific rim continues toshow economic strength.

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The third fiscal quarter ended on Friday on a bearish note, although US equities are once again flirting with lofty all time highs.  The lagging volume and consolidating technical pattern of all the major markets, coupled with a slight move to the downside on the last day of a bullish quarter could lead some to believe that the approaching apex of 14,024 in the DJIA could be a very convenient wall of resistance and an impetus of a substantial retracement.  The fascinating thing to me is that the ambivalent perception of the impact of forthcoming economic data, continuing debate over the severity of global credit issues, a totally devalued dollar, astronomical energy and commodity prices, and totally undefined corporate earnings are meeting at a plexus right at our ALL TIME highs.

One could easily hold a position that the major averages are not really trading at these levels at all, simply smoke and mirrors resulting from band-aid policies of liquidity infusion and interest rate cuts.  With October a historically foreboding and bear friendly month, this may not be the time to speculate with any long directional positions that are not completely hedged, with locked in loss parameters (i.e. appropriate options strategies/spreads).  From a technical aspect, the DJIA recent bull activity seems a bit overheated, and the Fast Stochastic %K has crossed over the %D moving down from overbought areas.  Meanwhile the SPY, or spiders, the tradable index of the spx, has formed a fairly symmetrical tightening triangle on constricting volum