Traders position for hot-season downside in small-cap sector
Today’s tickers: OSTK, WEN, MTN, IWM, VIX, FCL, STLD, WM, CTXS, NTRI, MGM, AA
OSTK – The mood of midsummer anticlimax that we noticed in options on the Russell 2000 index fund was in evidence in options of another small-cap stock, online discount merchant Overstock.com. Shares in the company rose 5% to $13.92 this afternoon, but a six-fold increase in option trading volume shows many traders taking the opportunity to stake bets on limp share price movement heading into the hot season. With implied volatility in Overstock.com options nearing a three-month high, it looks like a trader positioned long in June in-the-money puts at the 17.50 strike for $5.37, financing the purchase with the sale of puts at the 12.50 strike for $1.82. While the sale of the lower strike put indicates a clear limit to the kind of downside that the trader could expect, the net $3.55 debit initiating the trade doesn’t turn to profit for the trader until Overstock.com shares fall below $13.95 – roughly on par with current levels. For this trader, it’s a clear anticipation that the buck stops right about here for Overstock.com.
WEN – While some of its fast-food peers find success in recessionary times, luring the dine-and-dash crowd with value menus and flavored coffees, hamburger chain Wendy’s has struggled to find its equanimity. This was driven home to investors last week when the company reported a second straight quarter of declining same-store sales. The fact that the company has languished on the LBO market for nearly a year hasn’t helped the company consolidate and focus its identity in the fast food market. That said, with shares down .38% to $23.38 – within a buck and change of its 52-week low – a 14-fold increase in option trading volume appeared situated in a 5,000-lot collar position in the September contract. The collar is a cautiously bullish position entered by traders looking to protect hard-won gains for a vulnerable long position in the underlying stock. In this case, the trader would have bought September 17.50 puts for 65 cents, selling calls in the same month at the 25 strike for $1.70. In addition to coming out $1.05 ahead on the deal, the trader indicates a willingness to sell Wendy’s stock for $25 – which, given the company’s buyout blues, could be an implicit statement on the lack of price premium that a would-be buyer would ante up for the company’s third-largest burger chain.
MTN – Recessionary times often put a crimp in those resort vacation plans. In that sense, it was little surprise to see shares in Vail Resorts, the owner of the Colorado-based Breckenridge Mountain and Beaver Creek Resort, take a 4% hit to read $47.07 this afternoon. Of interest to us was an increase in trading volume that measured up to more than half the total open interest in Vail Resorts – and 26 times the normal level. This volume appeared to involve 3,500 lots in the May contract at the 55 line, where it appears that the calls were sold for 45 cents, and the deep-in-the-money puts were bought for $8.10 – a position that despite its appreciable intrinsic value is still 10 cents shy of a breakeven on the trade. A trader in this instance may be looking for a wave of belt-tightening among the resort-going crowd finally making its way to the bunny slopes. Shares in Vail Resorts are down more than 11% for the year to date.
IWM –After an ignominious start to earnings season yesterday, option traders may be seeking shelter from a fomentation of bearish sentiment heading into the month of May in the small-cap sector via puts in the iShares Russell 2000, an ETF correlated to the small-cap sector of the U.S. stock market. Components of the closed-end fund include recent movers PetroHawk Energy and priceline.com. Early today we observed a 3,500-lot put spread go through at strikes 66 and 70 in the May contract. The trader in this case appears to have funded the $2.28 per-contract purchase of the 70-strike puts by selling the lower strike puts for $1.03 in a transaction that becomes profitable for the buyer with a decline in the Russell 2000 Index Fund below $68.87 before May expiration. In the near-term, we observed heavy buying interest in April 70 calls, while puts at the same strike traded mostly to sellers, indicating some divergence in sentiment for the near-term direction of the share. The IWM reversed early gains to read .44% lower at $70.65.
VIX – The same sense of market underwhelming that we observed in the IWM could be discerned in the measure of composite implied volatility of the S&P 500, a figure expressed in the CBOE Volatility Index. The index, which tends to move inversely to the S&P 500 as fears mount over possible index losses, rose 2% to a reading of 22.88. It seems as though this jaunt higher in volatility – modest though it is - is being driven not by so much mass unease over unknown exposures in the financial space (which recent actions by the Federal Reserve have done much to allay), but by a sense of inadequacy over hard earnings numbers this quarter. Regardless, option traders appeared eager to seek protection from imminent moves higher in the volatility index at the April 27.50 call strike, which was bought heavily at 30 cents per contract. The same strike also attracted buyers in the June contract, which was bought for $1.40.
FCL – Yesterday’s raise in profit guidance from Arch Coal reminded many segments of the market of a still-ongoing rally in the coal sector, a sector with further upside potential the form of new coal-to-gasoline plants and zero-emission technologies. It is against that backdrop that we observe today’s 7% gain in shares of Foundation Coal Holdings, the Appalachian coal mining concern that produces some 72 million tons of coal annually. With the share price at $58.79, within $2 of its 52-week high, our market scanners detected an increase in option trading volume to 9 times the normal level. This was localized in May 60 calls, which were bought heavily at $4 apiece, implying a break of 5% past that high in the month coinciding with its May 2 earnings report. Options traders have otherwise held twice as many bearish puts positions as calls, a proportion that has remained more or less stable since December.
STLD – Steel sector M&A chatter continues to make the rounds among option traders today, as evidenced by a flurry of call activity in Steel Dynamics (SDI), the $7 billion-capitalized company which is the country’s fifth-largest producer of carbon steel products. Earlier today we observed a bump up in options volume to two and a half times the normal level, with fresh buying and selling in front-month calls at strikes of 40 and 42.50 that appears consistent with speculative activity on back of deal scuttle. What’s interesting here is the lack of follow-through today in SDI’s share price, which currently reads 1.3% lower at $36.88. There’s no denying the virtual halo of bullish anticipation surrounding SDI shares of late – last Thursday its implied volatility reading jumped from 27.5% to some 61% in tandem with a massive accumulation in call positions (SDI’s 133,000-strong open interest now consists of twice as many call positions as puts).
WM –In our first morning update yesterday, we observed a good many option traders responding with distrust to otherwise riproarious upside price action in on speculation of a private equity investment. Bumper gains for the stock met with heavy buying WaMu in April put strikes of 11 and below, extending into the May contract. Today’s confirmation of a $7bn infusion from TPG – while appearing on the surface to provide a vitamin-boost to WaMu’s bid for solvency – validated yesterday’s distrust among option traders. While the TPG deal will be dilutive to shareholders, WaMu also reportedly plans to cut its dividend to a penny a share. Shares took a 10% nosedive in early trading to $11.83, with April 11 puts trading mostly to buyers on volume exceeding its 38,000-strong open interest. Heavy two-way traffic is observed in April calls at strikes 12.50, 14 and 15. Total active volume in Washington Mutual is twice the normal level.
CTXS –Shares of Citrix, the maker of so-called virtualization and remote-access software for thin (Internet) clients, rose nearly 7% in afternoon trading to $33.00 on no apparent news catalyst. Last Wednesday its shares moved heavily on a Goldman Sachs upgrade, and while implied volatility at 59.6% shows a 42% elevation above the historic reading, it’s clear that option traders believe the stock is ripe with potential volatile energy. Earlier unsubstantiated rumors suggested a possible bid from Cisco, which would explain the doubling in option volume and 15% spike in implied volatility. A drill-down of the option activity earlier today showed a couple of divergent tendencies. Puts at the April 30 strike appear to have been bought for 75-80 cents, while calls at the same strike in September were bought for $4.20 apiece. This latter move implies a 4% upside move for Citrix shares by September, but the hefty price tag on this position may have been defrayed in part by the sale of calls in the January ’09 contract at strikes 40 and 45.
NTRI - Shares in celebrity-endorsed diet company Nutri-System gained 26.5% to $18.99 after the company replaced its CEO and offered buoyant guidance on Q1 sales. With all the flexion of a yo-yo dieter, today’s news flow represents a dramatic bounce back from what we observed in its options as recently as October, when Nutri System appeared to be struggling under the weight of supermarket over-the-counter drug Alli. Options are trading at 3.6 times the normal level this morning, with 3.6 calls trading for every put. This is heavily concentrated in call buying at the April 20 strike, which is already trading at more than triple the open interest. Implied volatility at more than 71% shows option traders pricing in more than a third additional price risk to Nutri-System shares over the next month.
MGM – The past two sessions have shown a reversal of fortunes worthy of the Vegas strip in MGM Mirage. Yesterday its shares traded sharply lower on a pair of analyst downgrades and reports that Dubai World would not raise its stake in the casino. This morning we encountered reports that Dubai World had in fact filed to raise its holding from 9.4% to 14.75%, news that may be driving the modest .38% increase in share price to $58.10 and more than tripling in option volume heavily situated in front-month call buying at the 60 and 65 strikes. MGM Mirage shares are currently trading at just a $1.27 premium to the 52-week low.
AA –Yesterday’s option traders anticipated a larger-than-usual implications from Alcoa earnings, and for those positioning long volatility, the big move came in extended trading with a 5.8% decline in the immediate wake of the numbers. Implied volatility in Alcoa options has subsided largely, down some 15.6% this morning, bringing option premiums sharply lower – case in point is the 37.50 straddle, which commanded as much as $3.50 yesterday ahead of the earnings announcement. Today that position has declined in value by more than a third, suggesting that the smart move yesterday would have been to sell volatility rather than buy into it. Options are trading with a volume bias to calls by a factor of 1.4, however, with a decent level of buying interest in 37.50 calls and selling pressure in puts at the same strike. Shares are down 1.5% at $36.88.
Andrew Wilkinson and Rebecca Engmann Darst
ibanalyst@interactivebrokers.com
Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.
