Wednesday, December 19, 2007
World Futures & Options Report
Today’s themes –British Pound, S&P 500 Index, Cheesecake Factory Call Options
Let’s All Pick on Sterling!
Apparently it’s open season on the British pound. That’s the message emanating from several sources these days. What’s more, the pressure seems to be across the board as analysts are even predicting that the pound will weaken against the Japanese yen. We note this given the traditionally wide yield spread between the two.
First of all, we must point out that it’s not just sterling in the crosshairs. It seems that the U.S. dollar, as we have been pointing out for weeks in this column, has potentially turned and has found a whole new breed of Johnnie-come-latelys to the party. Suddenly there’s no shortage of dollar bulls. Where were these guys a month ago?
The March dollar index future is now sitting pretty at 3.8% above its late November low-point. The latest leg-up for the dollar came courtesy of the announcement of money market intervention to the tune of $30 billion between the Fed and the ECB. In the event the ECB has added Eur348 billion cash to alleviate year-end bank funding pressures, and this may have the dual impact of taking added strain off the dollar, given the potential success of the solution. But it might also weaken the euro, given that traders are suddenly asking, “Hey, where did the ECB come up with Eur348 billion?” As they do, they are pointing to the potential for inflationary concerns if indeed the ECB has just fabricated this infusion via the printing press.
Chart: Interactive Brokers
Chart: Interactive Brokers
We make it that sterling strengthened against the dollar to a November 9 peak at $2.1161 while the currency market collectively picked on the dollar. The chart above includes one of the better trend studies for currency trading. The ADX/DMI indicator shows three lines. Focus only on the yellow line, which measures the ADX. Most of the time this indicator doesn’t perform well, since it is supposed to measure the strength of trend. When an asset is range bound, the reading is pointless. So for the technician, the meat of this story comes to the fore when ADX exceeds a value of 20. When ADX accelerates to above 40, a very real and strong trend is in place. Of interest to us here is that only in December, after having fallen to $2.01, did the trend start to flash red. This tells us that there really could be some meaningful lurch to the downside ahead for the pound.
Investment bank analysts note that on a purchasing power of parity, the pound is perhaps 25% overvalued against the dollar. Meanwhile, European banks are predicting a 6% slide in the pound versus the dollar into 2008. But outside of the core cross rate, how do investors play this trend? Interactive Brokers offers its customers six further cross rates to play. Investors can trade sterling against currencies of Europe, Australia, Canada, Switzerland, Hong Kong and Japan. Several weeks ago we noted the potential for sterling to weaken against the Swiss franc. This week we’ll look at its prospects against the Japanese yen.
Chart: Interactive Brokers
Chart: Interactive Brokers
With this possible over-valuation, some have suggested that the low-yielding Japanese yen might be a prime candidate for appreciation against the pound. The chart shows pretty tough sterling support at somewhere around 220, but the overall picture might be pretty negative for the pound. Sterling’s big summer-time push to above 250 soon met with a collapse to 220, while the recovery as far as 240 has met with persistent selling. The current chart position shows the formation of a consolidation triangle over the last month. It would appear that 230 should be pegged as tough sterling resistance, with short sellers looking for a break of the ascending support line and ultimately an assault on 220 before a push to “new ground” at 200.
S&P 500 index
Implied options volatility continues to fade away as we head towards year end. Some rationale might include that confident dollar, perhaps predicting better times for the U.S. economy ahead. Some of the reason may include bigger than expected losses at investment banks. We note today’s $9.4 billion write-down at Morgan Stanley accompanies a near 4% rally in its shares. Perhaps investors feel that the bleeding is almost over. Still the broader S&P 500 index is still 26 handles lower than just one week ago for a 1.8% loss.
Chart: Interactive Brokers
Chart: Interactive Brokers
As we head into year’s end, one has to wonder whether there is much more point to the pessimism we’ve felt in the final quarter. Of course, the real weight of money will shine through, but given the plethora of reasoning as to why the economy will suddenly come to a standstill, starting at the housing market and culminating in the potential for high energy prices to crimp retail spending, the evidence has to date only shown up in weaker confidence measures. A rebound in the financial services sector could very rapidly change the broad appeal of the index over the next few days, and that means that 1500 and above is a viable target for the end of 2007.
U.S. Equity Options Movers – Cheesecake Factory CAKE – Unusual Options Volume
On the same day that Orlando-based Darden restaurants announced a decline in earnings and predicted that it won’t be able to meet earnings expectations for the year, shares in Cheesecake Factory took off to the races. Darden owns Red Lobster, Olive Garden and Longhorn Steakhouses and blamed a challenging consumer environment with rising food costs. Its shares plunged more than 18% to $29.70. At the same time Cheesecake Factory’s share price jumped from a 52-week low by 6% on news than billionaire investor, Nelson Peltz, has been cleared by a U.S. Federal Trade Commission early antitrust hearing today. The move clears the way for Mr. Peltz to buy shares in the company.
Our option market scanners picked up on heavy call buying in CAKE. While shares undid two months of selling pressure in the stock, call option buyers were quick to place money on the fact that shares would end the week trading above $22.50. Calls at that strike have current open interest of just 723 contracts, but in today’s action traded 4,182 times. At the 25 strike open interest of 923 lots compares to today’s volume of 1,332 lots. The delta on those calls is just 20% and so indicates a one-in-five chance that the rally will extend that far in just two more days.
More popular are the January 25 calls where open interest is half as much as today’s 5,000 volume. Delta stands at 39% indicating how another 30 days improves the odds of such a trade paying off. The cost of securing a slice of the cake at $25 is currently 0.80 per contract.
Chart: Interactive Brokers
Chart: Interactive Brokers
Our option scanners also picked up on a surge in implied volatility on Cheesecake options as it surged by around one-quarter to 44%.
Andrew Wilkinson and Rebecca Engmann Darst
ibanalyst@interactivebrokers.com
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