Today’s tickers: XLE, AN, KMB, VIX, WB, F, AIG, DFS, EMC, INTC
XLE – Today’s $9 pullback in oil prices tempered some of the overweening bearish sentiment driving stocks lower, and sending shares in the Energy Select Sector SPDR 3% lower to $79.78. Given the overtones of Fed Chairman Ben Bernanke’s congressional testimony earlier today – which stated a fairly blunt case for demand erosion as well as his own commitment to combating the overarching inflationary threat – we were interested to see whether option activity would confirm or dispel a longer-term pullback below the $80 level. August 80 XLE puts are indeed extraordinarily active this afternoon, trading on volume of some 50,000 lots – which is more than half the accrued open interest at that strike. We’ve noticed however that the options here are being sold more often than bought, which could be profit-taking from traders who opened positions on Friday when the contract could be had for $2.88. Today’s ticket price is $3.57. In general, however, it is worth acknowledging that the 4-to-1 overweight of put positions relative to calls indicates a very defensive posture among traders who are taking the demand erosion argument very seriously.
AN – Manna from heaven in the form of a $9 pullback in the price-per-barrel of oil helped leading automakers today…but did very little for the likes of Autonation, the nationwide car dealership chain. Shares slumped 5% to $7.69 as we registered an increase in option trading volume to 28 times the normal level due to a massive, 31,000-lot position in October 5.0-strike puts. The 35-cent price tag on these puts – a 75% increase from yesterday’s level – and the 102% implied volatility (higher than the 89% reading on all Autonation options) suggest that these puts were subject to buying pressure. In any case, the implication here is of another 40% decline from current share price levels by mid-October, and looking at implied volatility versus the historic reading on Autonation stock allows us to infer that option traders are pricing in about 86% more potential turbulence to Autonation shares than they have shown historically.
KMB – Shares in Kimberly-Clark, the maker of Huggies diapers and Kleenex and Cottonelle tissues, bottomed below its 52-week low with a 5.1% decline to $55.79. Earlier today the company pre-announced Q2 earnings that revealed inflationary pressures taking a big chunk of its bottom-line. The company’s CEO also indicated that Kimberly-Clark would be passing these higher input costs along to consumers via sweeping product price hikes for the second time this year. Implied volatility on all Kimberly-Clark options rose nearly 23% this afternoon to 28.4%, ranking it among the day’s top-50 implied volatility gainers. This was accompanied by an increase in trading volume to 7.5 times the normal level, with what appears to be a preponderance of credit spreads involving August 50 and 55 puts – possibly indicating that some traders feel today’s selloff is overdone.
VIX - Fed chairman Ben Bernanke’s testimony before the Senate Banking Committee earlier today soberly acknowledged the asteroid field currently pummeling the nation’s economy – spreading financial sector dysfunction, putrid consumer sentiment, high food and energy prices, declining home values, and rising joblessness. But averring that the Fed remained focused on the inflationary threat as Job One, coupled with an implicit acknowledgement of the country’s current recessionary malaise, brought increasingly frustrated market participants to embrace a common theme: demand erosion for oil. Shares are now off morning lows as oil prices have staged a jarring $9 pullback. Against, this Grand Guignol backdrop, the CBOE Volatility Index brushed a reading of 30 earlier in the day as traders grappled not just with Bernanke’s testimony but also the implications of a Fannie Mae/Freddie Mac bailout being dropped into the laps of already severely tested U.S. consumers. At present the Volatility Index is off its highs, down 3% at 27.58, but continued buying interest in VIX calls in the August contract at strikes 30 and above supporting this “slow grind higher” scenario that has been taking shape for the past several sessions amid successive losses in the S&P.
WB – Meanwhile, the “Grand Guignol” to which we alluded earlier continues apace in the financial space today. Implied volatility in Wachovia options rose 21% earlier today after Oppenheimer analyst Meredith Whitney cut her rating on the stock, calling the outlook for the bank “bleak,” and telling Bloomberg News in no uncertain terms: “(Financial) stocks won’t be taken seriously by investors until they revalue dramatically – and Wachovia is the outlier.” Though implied volatility has since come off its blistering highs amid more subdued share price action (shares are 1.2% lower at $9.73), earlier today option traders wasted no time in selling July 10-strike calls for 20-cent premiums, while buying heavily into July 7.50 puts (which expire on Friday) for 25¢. The premium on this position denotes a 10% likelihood of Wachovia shares breaching the $7.50 by that time. Interest in low-strike puts extended into the August contract at the 7.50 strike.
F – Before a $9 pullback in oil prices gave rise to an abrupt turnaround in the fortunes of automakers, it was news of GM’s recessionary restructuring that sent traders looking for downside protection in both it and Ford, where shares are currently trading flat at $4.66. Even with shares trading higher in late-morning action, it’s been hard to gauge much enthusiasm for Ford from option traders. Earlier today we noticed activity from at least one option trader sees a slump below $4 as more or less an inevitability, buying a 10,000-lot position for 37-cents at the August 4 put strike. This position may have been funded by shorting a December call spread between strikes of 5 and 7 – which he or she would have done if confident that neither strike was likely to be exercised by December 19 – for a net credit of 56¢. If this is the way the trade played out, the net credit on the December spread would have covered the entire cost of the protective August position and left the trader with a 19 cent credit besides.
AIG – Implied volatility in multi-line insurer American International Group rose 37.6% earlier today to 152.8% today – fast approaching 3 times the historic volatility on the stock, and quantifying in fairly stark terms the level of perceived price risk that the options market is pricing into AIG shares. Though implied volatility has pulled back somewhat as AIG has pared some losses to 5% on the session at $21.49, it remains at the highest level we have on reading for AIG. Heavy put volume appears to involve July spreads between the 20 and 22 strikes, with fresh volume in August puts favoring the 19 strike again at $2.24 per contract – up one-third in value overnight.
DFS – Options in credit card issuer Discover Financial are trading at nearly five times the normal level as shares read 4.7% higher at $13.54. The action here appears in a put ratio backspread in the January ’09 contract, with a trader selling 3,750 lots at the January 15 strike and loading up on 7,500 lots in the January 10 puts. Even buying twice as many puts as selling them, the trader is able to pocket a $1 credit per contract on this trade, which wagers on volatile downside for Discover Financial shares heading into the first of the year.
ABX – Shares in the world’s largest gold producer, Barrick Mining Corp, declined .67% to $50.05 after announcing an unsolicited takeover bid for Calgary-based oil company Cadence Energy Inc. According to Canadian news reports, the bid was aimed at harnessing Cadence’s 3,600-barrel-per-day output to hedge up to one-quarter of the oil Barrick needs for its mining operations. Energy costs have been a major bane for metals producers, many of whom sustain a 1:1 increase in costs per rise in the price of a barrel of oil. With Barrick due to report earnings on July 31, corresponding with the August options contract, it looks like one trader may have anticipated the effect of high energy prices on Barrick’s bottom line, buying August 47.50 puts more than 4,000 times for $1.90 per contract in fresh positioning. The price tag on this position implies at least a 6% decline over the next month to break even.
EMC – Last week we noticed an increase in defensive position in EMC Corp options following the abrupt leave-taking of VMWare CEO Diane Greene. At that time (last Tuesday), implied volatility rose nearly 30% on the session to 51.2% as traders sought protection in August puts at the 13 and 14 strikes in seeming anticipation of an earnings shortfall on July 23. Today EMC Corp’s implied volatility continues to etch higher, ticking in at 54.4% as shares show a .32% decline to $12.60. Again, here some traders appear to be bracing for volatile downside on back of earnings, but are deploying a different strategy to express that view – selling about 11,000 lots in August 14 calls for 22¢ in a diagonal calendar call spread with January 12.50 calls, which were bought 11,000 times for $1.57. The trader in this case is taking advantage of a disparity in the implied volatilities of the two contracts (50.7% for the short August position and 44.6% for the long January position), betting that the value of the August position will decay more quickly (especially on back of an earnings miss). The value of the January position – in the mind of this trader – is likely to appreciate given some stabilization in EMC Corp prices at current levels by the first of the year.
INTC - Finally, Intel shares are trading 2% higher at $20.90 ahead of its after-the-bell earnings. While the price of the front-month straddle suggests a $1.36 move on back of the numbers (6%), early options volume today suggested option traders betting on fairly subdued price action, looking for shares to remain south of the $21 mark, but above $20. We noted preponderant selling in July 21-strike calls, but some evidence earlier today of credit spreads involving 19 and 20 strike puts, in which the traders would have taken a 30-cent credit betting on a close for Intel shares above the $20 mark by Friday. Implied volatility on all Intel options is ticking in at 46.7% against a historic reading of 36.3%.
Andrew Wilkinson and Rebecca Engmann Darst
Senior Market Analyst Equity Options Analyst
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.
