Back in Black 10-04-2011

Cusick's Corner
Holy Flux Capacitor! (Back to the Future) -- the market got back to the lows of 2010, 1050/1060, and as I noted in the Midday, I wanted to keep an eye on the higher beta Small Cap (RUT holding above 600) stocks into the After Hours. They have help into the close which has given some relief and would help explain the bounce in the general market. Another non trading catalyst today -- headlines out of the EU about potential bank bailouts. While I will take those headlines with a grain of salt, this late day push has squeezed the shorts into the close. The ADP employment number will be out pre-market, watch this paired with the headlines out of the EU could tip the stimulus hand and that could be an event which sparks the under invested. See you Midday.

Stock market averages surged in the final hour to finish with solid gains Tuesday. The table was set for morning weakness on Wall Street after European stock market averages fell again amid ongoing concerns about the banking industry and the risk of Greek debt default. Germany's DAX paced the decline with a 3 percent loss. In the US, the domestic economic news included one sole report on Factory Orders, which showed a decline of .2 percent for August and twice as much as expected. The Dow Jones Industrial Average fell as much as 250 points to 10,405 in morning trading, but the decline was orderly. At midday, the Dow had battled back to trim its loss to just 65 points and the tech-heavy NASDAQ was up 34 points. Then, market averages drifted lower again through most of the afternoon session until the Financial Times reported that EU officials were working on a bank recapitalization plan. European officials from Germany and the UK are apparently in favor of the move and want to implement the plan quickly to ease market concerns. The euro and stocks rallied on the headline. At the closing bell, the Dow Jones Industrial Average was up 154 points and more than 400 points off session lows. The NASDAQ added 69 points.

Bullish
Valero (VLO) fell to new 52-week lows of $16.40, but rallied in afternoon action and finished the day up 79 cents to $17.96. Meanwhile, options volume on the oil refiner 4X the daily average. 48,000 calls and 7,900 puts traded on Valero today. The top trades were part of a ratio spread, in which the strategist bought 10,000 December 20 calls on the stock at $1.12 and sold 20,000 December 28 calls at 6 cents per contract. Therefore, a Dec 20 - 28 (1X2) call ratio spread was initiated for a $1 net debit. The spread might roll down a position from the 28s to the 20s after a decline of roughly 40 percent in shares since March. Or, if opening, the spread is a bullish play with an upside breakeven at $21 (excluding transaction costs) through the December expiration, which represents a 16.9 percent rally over the next 73 days. There is additional risk to the upside in call ratio spreads, as only half of the higher strike calls (which were sold) are covered by the lower strike calls (which are bought).

Bullish trading was also seen in CREE, AMR and Sprint Nextel (S).

Bearish
Carnival Cruise (CCL) shares have been sinking and some players in the options market seem to expect the trend to continue. Although CCL rallied late today to close the day up $1.05 to $30.66, shares of the cruise ship operator are down 33.5 percent year-to-date and touched new 52-week lows of $28.52 Tuesday. Options volume in CCL included 16,000 puts and 2,025 calls, which is 4X the daily average for the stock. January 20 and 25 puts both traded more than 7,000 contracts and were the most actives. The activity included some spread trading, in which one or more investors were buying January 25 puts and selling January 20 puts - creating bearish vertical spreads for $1.20 (average) debit. It's a bearish play, with a max payout if shares fall to $20 (-34.8 percent) through the January 2012 expiration (108 days).

Bearish trading was also seen in Wells Fargo (WFC), Research In Motion (RIMM), and Cypress Semiconductor (CY).

Index Trading
CBOE Volatility Index (.VIX), which tracks the expected volatility priced into S&P 500 options, fell 4.63 points to 40.82 after stocks surged in the final forty-five minutes of trading. The S&P 500 Index (.SPX) rallied from about 1,081 at 3:15pm ET to close up 24.72 points to 1,123.95. Today's wild action triggered a lot of activity in the index market. 1.20 million puts and 810,000 calls traded across the S&P 500 Index, VIX, and other cash index products, which is about 1.3X the recent average daily levels, according to Trade Alert data. SPX October 1070, 1090, 1100, 1050 and 1000 puts were the most actively traded index contracts, as some players might have been initiating hedges as stocks sank in morning trading and then others scrambled to cover put positions as the S&P 500 surged late in the session.

ETF Action
An interesting spread traded in the iShares Small Cap Fund (IWM) Tuesday morning. Shares opened at $60.32 and, in early action, one strategist bought 75,000 November 63 calls on the ETF at $3.43 and sold 150,000 November 68 calls at $1.54. So a Nov 63 - 68 (1X2) call ratio spread was initiated for a 35-cent net debit. The play is opening because volume exceeds open interest in both contracts. IWM finished the day up $3.80 to $64.79 and the Nov 63 calls are already $1.79 in-the-money. The best payoff from the spread will happen if shares move to $68 through the November expiration. At that point, the 63s are worth $5, but the 68s expire worthless. There is additional risk to the upside in call ratio spreads, as only half of the higher strike calls (which were sold) are covered by the lower strike calls (which are bought)