Today’s Tickers – XLF, C, CFC, BSC, EWJ, PG & VIX
It used to be the case that Wall Street could rely on a Friday rally inspired by aspirations of merger-Monday to follow the weekend. Today’s double-whammy of negative financial news has sown the seed of fear that contagion will appear effervescent on Monday.
Stock index futures didn’t really react to the front page of the WSJ earlier today and instead remained fixated by the outcome of the employment report. In the event the markets braced for a weaker start for stocks as payroll growth slowed below forecast to just 92,000 jobs. The slowdown was broad-based hurting services and government sectors. But the bigger news was plain for all to read this morning with a fresh bad dose of news carried by the press. First came news that banks will possibly be left carrying the can for agreed but incomplete leveraged private equity buyouts. Since June 22, some 46 deals in need of $60 billion in financing have been cancelled. Buyers for structured finance have disappeared back into the woodwork as credit risk goes through a period of contrition.
Second is the news that mortgage lenders are raising credit standards for mortgage applicants. Certain types of mortgages may disappear altogether and the news, although possibly overdue, is more than likely to extend the sour tone throughout the remainder of the summer selling season. Both pieces of news conspired to weaken financial related issues despite the slightly easier tone to bond yields in the aftermath of the jobs report.
XLF – Financial Select Sector ETF – Market bloodletting continued in the financial sector today, with the Financial Select Sector ETF (XLF) trading 1.31% lower at $33.06. With just over 125,000 contracts circulating at the top of the noon hour, we observed heavy traffic at the August 34 calls (35,000 lots traded) and 33 puts (17,000 lots traded), with both sides trading heavily to the ask. We regard this as evidence of at-the-money strangle-buying, wagering on a continuation of the generalized, ongoing volatility in the financial services sector. A buyer of the 34-33 strangle pays the combined premium of $2.25 in anticipation of an upside move to $36.25 or down to $30.75. The market is currently pricing in 15% more volatility than shares in this ETF have shown historically.
The number of open put positions as measured by open interest on this fund have surged from 2 million (7/23) to 3.3 million this week. The XLF share price down by 1% today at $33.17 looks set to test the low point created at $32.52 in Wednesday’s turnaround session. Options volume today of 161,000 lots at noon has 1.4 puts trading for each call. Overall, open interest has 3.7 times as many puts outstanding as calls indicating continued investor safe haven hunting.
C - Citigroup – Citigroup shares slid nearly a percentage point straight out of the gate on Friday, with more than 125,000 contracts moving in the first two hours of trading. Calls and puts are trading at near equal frequency, with premiums sharply favoring the put side and volatility positioning extending well into the September series. More than 10,000 lots moved this morning to the September 45 put, at premiums inflated some 25% at $2.75. The September 47.50 strangle also appears to have been in play.
CFC – Countrywide Financial Corp – Shares lost another 6%, trading at $25.28 at the top of the noon hour – options traders responded by putting more than 80,000 contracts in play. Three times as many puts are moving as calls. While most traffic is centered in the front-month August series, we did observe some 9,250 lots trade on the January 10.0 puts at a price of 1.30 per contract. Some of this traffic may be involved in spreads involving that month’s 15 and 25 puts, where volume of 6,000 lots was ascribed to both.
BSC – Bear Stearns - This morning’s 64,500 circulating contracts represent more than 15% of the total amount of Bear Stearns’ open options positions. The rush to buy volatility in this hot-button financial ticker is well justified, with shares down some 2% at $114.00, having recouped somewhat after being down as much as 7% in the first hour of trading. More than twice as many puts are circulating as calls, on premiums sharply elevated to the put side – a strong indication of bearish sentiment in the market. Tellingly, the heaviest volume has been concentrated at the very lowest strike in the front-month puts – the August 95.
EWJ - Record Q3 earnings from Japanese automaker Toyota, which reported a 32% rise in profits and bumper sales growth on every market except Japan, still wasn’t enough to propel the Nikkei Average above the breakeven point this morning. Hours after the Asia-Pacific closed, we observed a sharp uptick in volume in the iShares MSCI Japan Index (EWJ), of which Toyota is the leading component. Shares are down three-quarters of a percent this morning at $14.12, with options moving at nearly six times the average rate. Much of this can be attributed to the 26,775 lots logged to the at-the-money August 14 put at a price per contract of 0.25. Volume elsewhere on the option calendar was light with the exception of 4,000 lots traded in the December 15 puts at a price of $1.15 per contract. Investors seem to be bracing for further contagion to spill over to next week perhaps.
PG – Procter & Gamble management must be pleased with the fruits of their efforts but disappointed with investor reaction to fourth quarter earnings early Friday. The 8% rally in sales was leveraged into a 19% jump in earnings. The maker of Tide detergent and Duracell batteries having swallowed razor-blade maker, Gillette in 2005 has two aims: To create synergistic cost reductions of as much as $1.2 billion and to create consistent annual sales gains of 5% to 7%. On the first hurdle, they are close to home and have cut products and jobs as well as being on target to reduce global distribution hubs to 226.
Today’s announced growth in sales was largely organic with 4% to 6% arriving that way. Incremental growth stems from increased ad spending on the 20 product lines that have sales in excess of $1 billion. Some 50 new products have been launched in 2007, while smaller detergent bottles will hit store shelves staring in September. The fact that P&G has penetrated Latin and Asian markets to produce larger sales rates than domestically has an unintended boost as the exchange rate continues to boost base line profits between 2% and 4%.
Shares fell 0.5% to $62.95 and show little sign of breaking out of the $60-$66 price range over the last year. Options buyers remained cautious following the release and appeared to sell strangles at the 60/65 strikes indicating that they see no reason to for shares to sell off should the broad market move lower nor move higher should optimism return. Implied volatility at 18.2% is just a little over the 16% on the underlying shares. Finally, the same strangle in the January 2010 contract looks to have traded at a gross premium of 14.7 today. The breakeven for this longer-term position occurs at $45.30 on the downside and $84.70 to the upside. The put carries a 38% delta while the 70 call has a delta of 53%.
VIX – The CBOE Volatility index rose 3.7% to stand at 22.02 Friday. This will mark the seventh consecutive close above 20 for the fear gauge.
By 12:30 pm, the Dow Jones industrial average was 0.43% lower at 13,404.80. The S&P 500 index fell by 0.64% to 1,462.80, while the Nasdaq composite index declined 0.58 per cent to 2,561.24.
Andrew Wilkinson Rebecca Engmann Darst
Senior Market Analyst Equity Options Analyst
ibanalyst@interactivebrokers.com
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