Trading Update June 19th

Today we witnessed yet another explicit example of the proverbial ‘rope-a-dope’ trade in the broad indexes after the FOMC minutes were released around 2 PM. The current environment is known for building a bold perception for a short-term directional bias and then using a broad economic catalyst as a way to provide volatility in the opposite direction, otherwise known as the ‘rug-pull’. The bullishness seen from yesterday’s trading session as well as from the morning tape in names like Google GOOG, Netflix NFLX, and Mastercard MA was unquestionable. Also, the volume on the weekly options for many of these names has been aggressive indeed. Take a look at these few strikes above $900 on the Google calls.

The highlighted column shows the daily volume and as you can see all three strikes traded over 7,000 contracts. People are betting on higher prices despite the shakeout on the indexes and this type of volume could be seen across most of these high-flyer names going into the Bernanke’s speech. Unfortunately, the markets made many of these position holders second guess their decision as the S&P sold off about 20 handles to close down considerably for the day.

The FED’s comments came as no surprise to a lot people but traders were pricing in Bernanke to come out and make absolutely no changes to monetary policy and also refute some of the rumors that have been surfacing about a possible end to the current QE programs. Remember, the market is a discounting mechanism and markets floated higher off that same possibility. Once the FED issued statements about ending QE by mid-2014, that was all people needed to hear to start selling out of some of their short-term long positions. An interesting to note though, is the HFT and algorithm activity once the actual minutes were released. The moves we experienced within seconds could only be stimulated by computers & HFT. To move an ETF like the SPY several handles in seconds one needs to be able to push massive amounts of volume in very short timeframes. We also see liquidity dry-up during these types of economic releases due to the increased volatility.

Let’s showcase a major fake-out in the Financial sector which took place just after the minutes were released. Take a look at Bank of America BAC below, which has been holding over $13 for quite some time now and has recently been showing the possibility of a rally back up towards $14.

Remember folks, the idea is to pile retail traders in long looking for a solid breakout and then reverse completely along with the broad market. This type of activity has a profound effect on the weekly options market as you will see below in the a chart of the $13.50 June 21st weekly calls. What happens is premium spikes considerably and traps the retail money in on the wrong side of the trade.

This option above traded just under 30,000 contracts for the day which is a considerable amount for any option on Bank of America. Take a closer look at the option above though and note when most of the volume came into the option. Sure enough, the volume started to hit heavy right after the FED minutes were released and the stock shot up to $13.40. Most weekly call options charts today look exactly like what you see right here. In these scenarios, usually it’s the market maker that comes away with the money, not Joe Schmoe retail.

The reversal in the indexes puts traders in a difficult situation to assess for the rest of the week and going forward. Will this be the temporary high in the markets for months to come or will we just go into a massive consolidation period for the Summer and slowly push higher as we end the year? Either way, today’s action just put a wrench in most long bias trades and subsequently put a damper on call option prices across the board. Here at Sanglucci.com, the strategy we use to play markets like this is to stay on the short side of the options markets and bet against those expecting major breakouts & breakdowns. Unfortunately, it’s always easier said than done!

Stick with Lucci!