Traders accept weaker share prices as volatility retains its poise
Today’s tickers: VIX, K, AFL, UNH, BAC & HBC
VIX – CBOE VIX Index – The fact that the VIX index remains below a reading of 50 as global bourses fast approach cyclical lows indicates an acceptance of the inability of governments to act either fast enough or deeply enough to solve the economic downturn. It also tells us that there is a lack of panic as equity prices adjust downwards as sure as it tells us that house prices are likely to continue their own adjustment process. Today there is no single item spooking the markets, rather it’s the overall haunting process that continues unabated. A large volatility option trade implies traders are banking on a creep higher in the cost of options’ insurance over the next 30 days. The trade involved around 25,000 VIX call options where the March 55 strike was bought in exchange for the sale of 64 strike calls. The net premium of 1.20 implies a breakeven at expiration of 56.20. Elsewhere option traders bought the March 60 strike 5,500 times paying a 1.30 premium.
K – Kellogg Company – As the Dow industrials slips quietly to reflect dire economic prospects for a new era, we note that shares in cereal-manufacturer, Kellogg Company have also slipped below $40.00 creating a fresh low. Recent results showed revenue growth albeit at a tepid pace, hindered by the impact of a peanut-product recall. If global share prices decline and the dollar continues to strengthen, this adds to Kellogg’s woes as international expansion plans in Russia, China and Australia since foreign earnings are diminished. An investor sold January expiration call options at the 45 strike at a premium of 2.20 today reflecting a lack of confidence that shares will reflect a defensive staple posture going forward. Option implied volatility stands at a 33% level, which suits a staple-type company, which an investor intends to use to his advantage.
AFL – AFLAC, Inc. – The health and life insurance company received an upgrade by Morgan Stanley today raising it to ‘overweight’ from ‘equal-weight’. Despite the good news, shares of AFL have slipped slightly by 1.9% to $16.01. It appears that one investor took bold action in the March contract by selling 11,000 puts at the March 15 strike for 1.90 each, and sold an additional 11,000 puts at the March 20 strike for a premium of 4.90 apiece. Both lots sold to the bid and were marked as spreads provoking us to think that the sales were tied to short positions in the underlying stock. Perhaps this investor is short the stock and is simply generating income from the sales, although he would have the shares put to him if the current share price remains flat through expiration in March. AFL is currently trading at 123% implied volatility.
UNH – UnitedHealth Group, Inc. – The health and well-being company popped up on our ‘hot by options volume’ market scanner this morning due to a straddle initiated in the June contract. Shares currently have declined by about 2% to $27.87. The straddle involves approximately 10,000 calls sold at the June 28 strike price for a premium of 3.50 per contract, and the sale of 10,000 puts for 3.20 apiece. Thus, the net premium pocketed by the investor amounts to 6.70. This trader will retain the full premium if shares center at $28.00 by expiration, and his premium will begin to erode if the share price swings toward either of the breakeven points located at $21.30 and $34.70, respectively. Should the share price arrive at either of the breakeven points the investor will have watched all of the 6.70 evaporate away.
BAC – Bank of America – With nationalization discussions on trading desks a key theme today, shares in financial stocks are down heavily. After the billions of dollars already spent aimed at revitalizing the banking system, investors seem ready to throw in the towel and admit that they are at risk of having equity in these companies called away by the ultimate government rescue known as nationalization. It’s happened in the U.K., with the same idea floated in Germany this week and is fast becoming an inevitability in the U.S. Bank of America has plunged 17.8% today to $3.22 while option traders are trading the lowest available strike puts expiring in March like hot-cakes. Ahead of noon, the 34,900 puts at the 3.0 strike have changed hands with premiums jumping 60% on yesterday’s session to 74 cents. At this price the breakeven of $2.30 largely implies the share price associated with companies careening towards bankruptcy. Implied options volatility at BoA today stands at around 250%.
HBC – HSBC Holdings Plc ADR – Shares are off by about 3% to stand at $34.03 for the bank. Option traders were very active today in the March contract, where the trend seems one of constructing a patchwork quilt of call spreads and put spreads. Activity was skewed towards the put side, but investors can clearly be seen buying 35 strike calls and selling the 40 strike. Others bought 35 strike puts and sold those at the 30 strike. There appears to be a lack of conviction that there is a calamity looming with other investors playing for a quick rebound in the share price.
Andrew Wilkinson
Senior Market Analyst
ibanalyst@interactivebrokers.com
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