What's On Our Minds...

Options Action –

The show started out reviewing the week.  It was noted that the market gapped up strong the first trading day of the year (Tuesday) and then was in a holding pattern the next three days.  The feeling was this price action may show the market is waiting for 4th quarter earnings results which start to trickle in this coming week.  The first Dow Jones Industrial Average component to report is traditionally Alcoa (AA – 9.16) and AA reports their earnings after the market closes on Monday.  On Friday JP Morgan Chase (JPM – 35.36) will release their results.  These two reports along with the stock market’s reaction should provide some insight into business conditions in the fourth quarter.  These are also the two stocks that are used for trading recommendations on the show this week.

The first trade recommendation is a bearish one on JPM and based on the stock dropping on their earnings release Friday morning.  Since this is a short term trade, using weekly options that expire this Friday is suggested.  Bearing a bearish trade, a bear put spread is the structure of the trade.  Specifically, the trade is to buy the JPM Jan 13th 35 Put at 0.60 and sell the JPM Jan 13th 33 Put at 0.15 for a net cost of 0.45.  This trade breaks even if JPM is at 34.55 post earning and has a maximum profit of 1.55 (based on a 0.45 cost) if the stock is at 33.00 or lower.  Finally, the maximum loss is the 0.45 paid to initiate the trade and this occurs if the stock is at 35.00 or higher upon expiration.

The next trade discussed was on AA and is based on trying to get long for earnings.  This trade is a little more complex in the form of a risk reversal.  This trade sells a AA Feb 8 Put at 0.15 and buys a Feb 10 Call for 0.20.  The net result is a cost of 0.05, the obligation to buy shares at 8.00 and the right to buy shares at 10.00.  The risk is a dramatic drop in the share price and having to own shares at 8.00.  On the upside, if the stock rallies based on earnings, you have the right to buy shares at 10.00 between now and February expiration. 

Barrons –

In an interesting coincidence there’s a bullish article by Andrew Bary on Alcoa stock.  One analyst cites a price target for shares of 13.00 over the next 12 months.  A price level that caught my eye was that the tangible book value for the stock is 8.00 – the same strike price as the short put in the Options Action recommendation. 

The Striking Price column discusses the VIX and using it as an indication of options being cheap or expensive.  It was noted that the VIX is at a relatively low level (relative to the past few months) as earnings season approaches. 

As a reminder – the CBOE Futures Exchange (CFE) plans to commence trading in security futures on the CBOE Emerging Markets ETF Volatility Index (VXEEM) this coming Monday January 9th.  The VXEEM is a volatility index that is determined using option pricing on the iShares MSCI Emerging Markets Index (EEM) exchange –traded fund.  The futures will trade with the underlying symbol VXEM and contracts expiring in February, March, April, and May are planned for Monday.  A bit more color on the price behavior of the VXEEM relative to the CBOE Volatility Index (VIX) may be found in the following article that appeared in The Street earlier this week:

http://www.thestreet.com/story/11366496/1/cboe-global-volatility-feature-for-options-profits.html

Generally the first Friday of each month the Labor Department releases two very significant economic numbers.  Nonfarm Payrolls and the Unemployment Rate for the previous month are usually market moving pieces of news.  This morning the Labor Department reported that December 2011 Nonfarm Payrolls grew by 200,000 which was higher than market expectations of 150,000 new jobs last month.  Also the Unemployment Rate for December was announced at 8.5% which was better than 8.7% which was the average expectation of economists.

So why do these employment numbers get so much attention?

A couple of factors play into this.  First, these numbers are released early in the month and are the first look at what the state of the economy was in the previous month.  Today’s reports are the first pieces of data regarding December economic activity.  Second, hiring occurs when businesses expect growth and are confident about this growth.  Increasing the number of workers on your payroll increases your costs.  An employer will only do this if they expect to grow their business to cover these added expenses.

Volatility as an asset class

RF Micro Devices (RFMD) is recently trading down $1.03 to $4.60 following the company lowering its December quarter guidance. Overall option implied volatility of 51 is below its 26-week average of 56.
 
Alcoa (AA) is recently down 26c to $9.10 in pre-open trading following the company announcing the closing of 531,000 metric tons of smelting capacity and the expectations of a Q4 charge. Overall option implied volatility of 46 compares to its 26-week average of 44.
 
Proshares UltraShort Barc 20 Year Treasury ETF (TBT) overall option implied volatility of 38 is below its 26-week average of 42 into December jobs report.
 
CBOE significant put volume increases;
BAC 1/6/2012 6 23K contracts

WMB1 1/21/2012 30 10K
MON 1/21/2012 62.5 7K
WFC 1/21/2012 28 3K
AAPL 1/6/2012 410 3K
GM 2/18/2012 21 3K
NFLX 1/6/2012 75 3K
 
CBOE Volatility Index-VIX closed at 21.47, 10-day moving average is 22.14, 50-day moving average is 28.10.
 
U.S. equities are mixed into the December U.S. employment report.

Payrolls rose by 200k jobs.  The jobless rate fell to 8.5%.  Both of these were better than the consensus estimate. US stock futures up modestly.

The ADP monthly employment report was released this morning showing 325,000 jobs added in December.  This compares favorably to estimates of 180,000 to around 200,000 jobs.  What is interesting about the ADP report is it comes out just before the closely watched employment report from the Labor Department.  At times the ADP report does a good job forecasting what the official employment report says about the current status of the labor force and at times it has been off the mark.  Either way we will know at 7:30 central tomorrow if the two match up this month or not.

Stock Mover's
 
 
Seagate (STX) is recently up $1.08 to $17.90 in pre-open trading after the company attributes better than expected Q2 results to strong execution. Overall option implied volatility of 47 is below its 26-week average of 52.
 
Macy's (M) authorized an increase in its dividend to 20c per share and raises guidance for Q4 and the year. Overall option implied volatility of 35 is below its 26-week average of 41.

Sirius XM (SIRI) is recently up 4.4% in pre-open trading on the company saying it ended the year with nearly 21.9M subscribers. Overall option implied volatility of 48 is below its 26-week average of 57.
 

CBOE significant call volume increases;
 
MSFT 3/17/2012 28 11K contracts
IAG 2/18/2012 17 10K
MSFT 1/21/2012 27 9K
AAPL 1/6/2012 415 7K
BAC 1/21/2012 6 6K
PFE 6/16/2012 22 5K
AKS 1/19/2013 15 4K

U.S. equities are lower, as European stocks sold off on renewed tensions European banks will be required to raise additional capital.  Offsetting this were two good job reports in the US.  Weekly claims dropped slightly (the holidays are a difficult period to measure), but ADP reported that private sector jobs increased by 325k.  

It was the lightest-volume week of the year last week, and one of the least eventful as well.  That doesn't mean it wasn't an important one though, in that where the market left off last week is usually where – and how – it will start the New Year.  Of course, that doesn't necessarily tell is what's in store… bullishness or bearishness?  We did make some progress toward an answer though.

We'll look at the upside and downside below, right after digging a little deeper into the recent and upcoming economic numbers.

Economic Calendar

Not a lot of data was posted last week, but we got a few biggies.  One of them was on the consumer confidence front – the Conference Board's key sentiment figure jumped from 55.2 to 64.5 in December, which was the best reading in months.

On the unemployment front, new claims rose from 366K to 381K, but it's still under the key 400K level and trending lower.  Continuing claims also edged slightly higher, from 3.567 million to 3.601 million (though that data is a week behind the new claims number).  Overall, we're still seeing modest progress.

And as far as real estate/construction goes, we're still seeing a mixed bag.  Home prices are still sinking, per the 3.4% dip in the Case-Shiller Index, though pending home sales surged by 7.3%, hitting a nineteen-month peak.

The rest is below.

Economic Calendar

The big items coming this week are:

* Wednesday: Factory Orders – They should be up 2.1% for December, reigniting a stalled productivity effort.

* Thursday: New and continuing unemployment claims – the modest downtrend should be sustained.

* Friday: Payrolls-added and the unemployment rate – Jobs are expected to be created at a faster pace than we saw in November (+150K overall for December), though the unemployment rate is expected to move a hair higher, from 8.6% to 8.7%.  It's possible because of the way the unemployment rate is calculated using the eligible pool of potential workers… a number that can change every month because these people can change their minds every month.

S&P 500

Last week's 7.73 point loss (-0.61%) for the S&P 500 (SPX) (SPY) isn't that big of a deal.  It was also the lowest volume week of the year, largely because there were so few players, and nobody really cared one way or another.  In other words, it wasn't a majority opinion.  It did help us in one regard though… it helped form the make-or-break ceiling between 1268 and 1280.

The lower boundary for that resistance zone is basically where the SPX has topped out three times since early November (red, dashed) and where the 200-day line moving average (green) is, while the latter is where the upper 20-day Bollinger band is waiting (brown).  That upper band line actually hasn't been tested since late October, but given how well it's capped – or at least contained – rallies for several months now, we have to expect it to be a ceiling now.  If it doesn't end up acting as a ceiling though, then two months' worth of pent-up bullishness could be unleashed in a hurry.  [Yes, this was the same basic assessment we made last week; now we're one week closer to seeing it happen.

On the downside, two floors have had time to firm up.  The first one is the 1240 area, roughly where the 20-day and 50-day moving average lines are.  Below that, the lower 20-day Bollinger band (brown) and the 100-day average line (gray) have converged at 1207.  Even a retest of that lower support area could leave the bigger uptrend intact, though we don't want to have to test that theory.

Anything in between those named floor and ceilings, the market remains in limbo. Take a look.

SPX & VIX Daily Chart

As for the CBOE Volatility Index (VIX) (VXX) (VXZ), it's still in a downtrend that's generally mirroring the S&P 500's broad uptrend.  But, there's reason to be tentative about the VIX's pullback… the downtrend we've seen for the last three months is the most we've seen the VIX fall in a long, long time.  That – paired with the fact that it seems to be pushing up and off its lower Bollinger band – could be an omen that it's looking to move upward, which is bad for stocks.

But hey – the VIX may have just put its downtrend on hold last week while most folks were on vacation.

Either way, the 25 area (where the VIX's 200-day and 20-day moving averages are) will need to hold the VIX down the next time it's tested if the bigger-picture rally for the market is to stay in motion.

All that being said, there's another perspective we want to take not just for the S&P 500, but for all the major indices (which is the market as a whole).

We have to zoom out back to July to do it, but all the indices are at the tip of wedge shapes.  The technical patterns are also known as sideways triangles and narrowing triangles.  The implication is that something has to give soon, and in the case of the Dow Jones Industrial Average (DIA), it has… the upper edge of its triangle pattern has already given way. Granted, the Dow is still dancing with resistance at 12, 284, but it along with both the NASDAQ (COMP) (QQQ) and the SPX have been in consolidation mode for a little too long to not expect fireworks soon.

And, the shape of things is saying the undertow is slightly bullish – bullish enough to expect a bullish outcome slightly more than looking for a bearish outcome.  But, all the indices still need to leap their other technical hurdles for the triangle 'squeeze' to matter.  Take a look.

Dow Industrials, S&P 500, & NASDAQ – Daily

We're getting there though.  

Trade Well and Happy New Year!

Price Headley
BigTrends.com

Today’s morning economic report consisted of Factory Orders for the month of November.   The consensus estimate was for a rise of 1.9% from October.  The October Factory Orders report showed a drop of 0.4%.  The number released at 9:00 am Central time with a rise of 1.8% which was a little below market expectations of 1.9%.  Also, there was a revision to the October result with orders showing a drop of 0.2% versus the previously reported drop of 0.4%.  Revisions in monthly economic numbers are common.

So what exactly is the Factory Orders number? 

The Factory Orders number is a combination of durable and non-durable goods that have been ordered from factories.  The breakdown is about 50% durable and 50% non-durable goods.   The number is compiled by the Department of Commerce and released on a monthly basis.  Economic number watchers actually do not pay too much attention to this report.  Non-durable goods are usually staples with consistent demand.  The durable goods component is more volatile and gives more insight into the overall economy.   There is a separate economic release, Durable Goods Orders, that provides better insight into this component of Factory Orders. 

So what does the number mean for Traders and Investors?

The Factor Order number is a good 50,000 level view as far as economic growth however it is one of the last numbers to come out showing activity in November.   Also, it is released the same week as the very important employment number which comes out this Friday and that is normally the focus of the markets the first week of each month.

Volatility as an asset class
 
Proshares UltraShort Barc 20 Year Treasury ETF (TBT) is recently down 9c to $18.51. TBT overall option implied volatility of 39 is below its 26-week average of 42.

Market Vector Gold Miners (GDX) is recently down 45c to $53.35. Gold is recently down 0.32% to $1535. Overall option implied volatility of 35 is below its 26-week average of 37.

iPath S&P 500 VIX Mid-Term Futures Index ETN (VXZ) overall option implied volatility of 43 is below its 26-week average of 47.

iPath S&P 500 VIX Short-Term Futures (VXX) overall option implied volatility of 73 is below its 26-week average of 82.
 
 
CBOE significant call volume increases;
 
BPAX 6/16/2012 0.50 12K contracts
JCP 2/18/2012 37 10K
BAC 1/21/2012 6 9K
F 1/21/2012 12.5 7K
TLT 3/17/2012 122 6K
T 1/21/2012 30K 5K
MT 1/21/2012 20 5K
APOL 1/21/2012 55 5K
NEOP 1/19/2013 3 5K
MSFT 1/21/2012 27.5 4K

Stocks give up ground in slow pre-market trade.

Mead Johnson (MJN) is recently up $2.85 to $71.85 following public health investigators concluding that Mead Johnson's products don't contain Cronobacter bacteria. January call option implied volatility of 33 is below a level of 40 from last week and near its 26-week average of 32.
 
Bank of America (BAC) is recently up 4.9% to $5.83 after losing 58% of its value in 2011.  January call option implied volatility is at 62, March is at 47; compared to its 26-week average of 58.
 
Groupon (GRPN) is recently down $1.54 to $19.10 after N IPO opening of $28 on November 4, 2011. January call option implied volatility is at 67, puts at 111. Put volatility is higher than calls because shares are difficult to borrow and traders taking positions for additional downside price movement. 

Stocks are higher at mid-day, after manufacturing data from the U.S., China and India all beat expectations.
CBOE Volatility Index-VIX is recently down 31c to $23.09, below its 50-day moving average of 28.44.

Moving Forward

I would first like to wish you and your family a happy, healthy and prosperous New Year.  It’s always at this time we take a moment to reflect on what we have, I am grateful for a wonderful family, good health and outstanding community of market traders like you. 

While some turbulence was seen in 2011 one great thing was getting Explosive Options started in May.  I’m dedicated to bringing you good trading ideas, content, education communication – to all who want it.  Expect more big things in the year ahead.

No question this past year has been one of the most turbulent we have seen.  Of the more than 200+ trading days the Dow Industrials moved triple digits 100 times. 

Market volatility was more like taking a ride in the spin cycle, there was little smoothness to be had.  The one consistency was uncertainty.  As we know markets hate guessing an outcome - more reliable is preferred.  However, trying to guess where our political future is going, Europe’s debt crisis solution and the economy make for lots of opinions. 

I cannot recall such a challenging year for trading.  Even some high profile professionals like my colleagues James DePorre and Doug Kass at realmoney.com showed some frustration with trading in 2011.

It’s one thing to go straight up or straight down but moves this year triggered deep emotional moments (as reflected in the VIX below).  Money was flowing out of equities at a record pace, headed for safety.  With the big moves up and down, who could blame anyone for seeking the sidelines.

As we turn the calendar it is time to look at the chart (below) to see what it may teach us about the year ahead.  We can see below how the jagged edges of a turbulent year may have clocked many traders who have leaned the wrong way. 

Punishment is swift and painful in this unforgiving market.  That is the landscape we are in.  My best advice in 2012 and beyond – size your trades properly, pay heed to your rules, be nimble and quick, take profits and don’t be afraid to take a loss.  Know that it is OK to sell and take a position down – win or lose.

Finally, I am thankful to all of you for hanging in there with me through a turbulent year.  I am also grateful to my friends at cboe.com.  Thank you everyone helping to make 2011 a banner year for Explosive Options – moving ahead toward bigger stuff in 2012!

Bob Lang is the Founder of option trading newsletter Explosive Options

Volatility as an asset class

Nasdaq-100® Index Tracking Stock (QQQ) overall option implied volatility at 24: www.cboe.com/QQQ

Russell 2000® Index Options (RUT) overall option implied volatility at 29: www.cboe.com/RUT

S&P 100® Options with American-style exercise (OEX) overall option implied volatility at 20: www.cboe.com/OEX

CBOE DJIA BuyWrite Index (BXD) at 220.86, above 50-day moving average of 211.98: www.cboe.com/BXD

CBOE significant call volume increases;

AGO 1/21/2012 17.5 12K contracts

X 1/21/2012 26 7K

LEAP 1/21/2012 9 7K

SYMC 1/21/2012 20 6K

GDXJ 5/19/2012 27.63 6K

AMR 1/19/2013 1 5K

AGO 1/21/2012 14 4K

AAPL 12/30/2011 405 3K

INTC 2/18/2012 25 3K

MMR 1/21/2012 17.5 2K

U.S. equities are up ~ 1.5% in pre-open trading as global equity markets rally into optimism for 2012. ISM & Construction Spending later this morning.

CBOE Volatility Index-VIX closed at 23.39, 10-day moving average is 22.72, 50-day moving average is 28.68.

I love this time of year when all the fun stats from the previous year get thrown around.  The best tweet I read this weekend was that the S&P 500 index moved 3240 points to close unchanged on the year.  Lots of volatility for nothing…

Options Action –

The guys started off talking about the increased volatility for 2011 and how although the market moved around a lot we finished the year basically unchanged.  One interesting comment was that although the S&P was flat for 2011, the VIX is actually about 1/3 higher than where it settled at the end of 2010. 

The first trade recommendation was based on the price of gold.  Specifically using options on the GLD ETF (GLD – 151.99) and creating a bear put spread.  The spread involves buying the GLD Jan 156 Put for 4.40 and selling the Jan 151 Put at 1.90 for a net cost of 2.50.  If the GLD is at or below 151.00 at expiration this trade results in a profit of 2.50.  In fact, if the price of gold does not move between now and January expiration (very unlikely given the volatility we’ve seen in gold lately) this trade would still result in a profit.  A maximum loss of 2.50 would be incurred if the GLD rallies and is at or above 156.00 at January expiration.

The second trade is bullish and involves shares of Morgan Stanley (MS – 15.13).  A bull call spread using the MS Feb 16 and MS Feb 18 Call options.  The MS Feb 16 Call is purchased for 0.85 and the MS Feb 18 Call is sold for 0.30 and the net cost is 0.55.  If MS rallies up to 18.00 or above at February expiration then the trade turns out to be a winner to the tune of 1.45.  At any price below and including 16.00 this trade turns out to be a loser to the tune of the premium of 0.55 that was paid for the spread.

Barron’s –

The Striking Price column starts out talking about the success of buy-write strategies relative to buy and hold in 2011.  A review of the performance of several indexes in 2011 appears in the blog entry below –   

http://communities.cboe.com/t5/What-s-On-Our-Minds/BuyWrite-and-PutWrite-Indexes-Up-in-2011-by-Matt-...

Steven Sears column finishes up discussing 2012 and the VIX – the feeling is since Wall Street has been on vacation the past two weeks so the resumption of market volatility may start to occur in the near year.  More volatility may lead to a higher VIX.