All right - we’re finally starting to have some fun again!

After 3 weeks of miserable rolling, rolling, rolling we finally had a day where we got rewarded for our perserverence.  We rolled down to the GOOG $520s right out of the box at 9:35, did a rare TRIPLE down on the QID $40 puts at 9:52 and grabbed the BIDU $320s as a new play at 9:56.  We cashed out that set early in the day, other than the QIDs, ahead of the big dip but then got right back on the buying horse selling the DIA $112 puts at 12:59 (dead bottom) and buying the Russell $670s at 1:23, right before they took off!

All in all it was a very good day of grabbing some quick plays and the most important thing is that we were BOTTOM fishing on every single one.  When your bottom fishing starts working in day trading it is actually possible that you have found and real bottom.  Of course I did mention that this is how the Chinese investors must have felt when they bounced off the 20% line, over 30% ago, so we’re not going to go crazy and hit the BUYBUYBUY button just yet - we’ve already committed the most cash we have all year to our LTP positions as we rolled and rolled to follow the market down and we could sure use some lovin’ now.

Speaking of BUYBUYBUY, this is an amazing video of Cramer in action and a great example of why I don’t even bother listening to his show anymore.  I used to watch it to see which way he’s herding the sheep but this made me realize why that no longer works - he flip flops so fast, you can’t even follow the herd!  Cramer started his show with such promise it just pisses me off to see what he’s become.  He had an opportunity to really educate people about the markets and instead reverted back to being a carnival barker for whatever stocks his hedge fund buddies want to unload on the chumps - that’s why I’m hard on him, it’s just not right!

Speaking of evil, lying, media bastards, kudos to Xian for finding us the story that the State Department OFFICIALLY dismissed the report that Israel was likely to attack Iran at 12:52, which enables us to see clearly what a disgusting,unprofessional, manipulative outlet CNBC really is as they continued to run with the story every hour on the hour with guest aftet guest speculating on how high oil would go after the presumptive attack.  Even after the markets closed, they ran a special report on the rumor as if it were a fact and reported it as the driving factor in the price of oil, even as oil sold alll the way back to $140 at 2:25, only to be pumped back up at the last minute to $141.50 (as has been the case for the past week).

"I have no information that would substantiate that, and I think it’s rather foolish of people who often have no clue what they’re talking about to assert things and not even have the courtesy to do so on the basis of their name," State Department spokesman Tom Casey said.  For you Big Brother fans, notice how the 2nd part of Casey’s statement has been removed from the first referenced aricle (even though it was there when Xian first posted it) as well as most other US sources….

While we remain a little weary of any rally that is led by GM, we did hold our levels and that’s all we aimed to do this morning.  Tomorrow we get the always random ADP report and the market closes early on Thursday so we’re still going to have to be well covered into the weekend, no matter what the markets do tomorrow.  I’ll be happy if we can just hold 11,400 for the week as it might just look like we’re forming a bottom.

Today’s tickers: JPM, WFC, GE, THC, XLE, AKS, COF, XLY, MAT, GD, RTN, HRB

JPM- As recently as Friday we noted in this space that implied volatility in JP Morgan Chase options was at its highest level since March 17 as shares faced a grueling 52-week low. Since that time, the share price of this would-be “alpha wolf” in the financial space has eroded further (despite recovering late in the session to close .18% higher at $33.99) and its implied volatility, the 30-day forward-looking measure of perceived risk has continued to mount, up nearly 10% since Friday alone to 64.5%. This stacks up against the 47% historic reading on the stock, suggesting heightened and imminent risk of whipsaw action in JP Morgan’s stock price relative to its historic tendency. Interestingly, while we observed heavy buying activity in July 27.50 puts at 55 cents, which would require a very dramatic erosion below the 52-week low indeed (placing the share price at only slightly more than half the level of its 52-week high), it’s possible that some of this volume was involved in spreads at the 32.50 strike, most of which were sold for $2.00. Short credit spreads using puts at these strikes would imply traders taking in a $1.45 credit in the expectation that both puts would expire worthless as shares remained above the $32.50 level, essentially capping the downside. Call buying at the July 35 strike would also be consistent with that thesis. Long put spreads at the aforementioned strikes, however, would indicate traders battening down the hatches for a leg lower and the 35 call strikes may be hedges against short positions in the stock.

WFC- Shares in Wells Fargo joined sector peers in setting a fresh 52-week low today, before rebounding late in the day to close 1.5% higher at $24.11. While implied volatility at 62.4% shows an extra anticipated risk premium against the 46.9% historic reading on the shares, this level is slightly below the mid-March highs. Still, with nearly 4 puts trading for every call today on a volume of more than 92,000 lots, the defensiveness is about as subtle as a bull (…or rather, a bear) in a china shop. As we observed in other leading financials, to wit JP Morgan Chase, given the elevated volatility the tendency among traders has turned to spreads, which control trade costs, sacrifice profits for more adept management of risk, and allow traders to hone in on specific downside or upside moves. This appears to be the case among July put spreaders at strikes 22.50 and 27.50, where it looks like traders are buying the higher strike for $4.35 and selling the 22.50’s for 90 cents to break even at $24.05. It also looks, however, like some traders opted for a diagonal calendar put spread, selling out-of-the-money October 20 puts for $1.50 to fund the purchase of August 22.50 puts for $1.75 in a play that looks to capture on an anticipated spike in implied volatility on the closer-month August puts. This trader likely feels that despite the effects of time decay, the $1.75 price tag on the August put will increase before August 15 as Wells Fargo shares melt below $22.50.

GE- Shares in Wells Fargo joined sector peers in setting a fresh 52-week low today, before rebounding late in the day to close 1.5% higher at $24.11. While implied volatility at 62.4% shows an extra anticipated risk premium against the 46.9% historic reading on the shares, this level is slightly below the mid-March highs. Still, with nearly 4 puts trading for every call today on a volume of more than 92,000 lots, the defensiveness is about as subtle as a bull (…or rather, a bear) in a china shop. As we observed in other leading financials, to wit JP Morgan Chase, given the elevated volatility the tendency among traders has turned to spreads, which control trade costs, sacrifice profits for more adept management of risk, and allow traders to hone in on specific downside or upside moves. This appears to be the case among July put spreaders at strikes 22.50 and 27.50, where it looks like traders are buying the higher strike for $4.35 and selling the 22.50’s for 90 cents to break even at $24.05. It also looks, however, like some traders opted for a diagonal calendar put spread, selling out-of-the-money October 20 puts for $1.50 to fund the purchase of August 22.50 puts for $1.75 in a play that looks to capture on an anticipated spike in implied volatility on the closer-month August puts. This trader likely feels that despite the effects of time decay, the $1.75 price tag on the August put will increase before August 15 as Wells Fargo shares melt below $22.50.

THC- Shares in Tenet Healthcare gained 1.6% to $5.65 after reporting that it had completed the sale of two California hospitals for $41 million. Earlier today Tenet also reported that it had reached an out-of-court settlement with a real estate investment trust owning seven hospitals leased by Tenet subsidiaries. Despite fairly upbeat news for the stock, an increase in option trading volume to 14.5 times the normal level appeared heavily concentrated in November 5.0 puts, trading at 50 cents apiece on more than 3 times the open interest in seeming anticipation of a near-25% decline for Tenet shares by November, making today the heaviest volume day for Tenet Healthcare shares since last September. Open interest has shown a skew toward puts since mid-June, now weighing in heavier than the calls by more than 2-to-1.

XLE- US stocks reversed losses in afternoon trading, after oozing into bear market ague earlier this morning. The culprits for this morning’s slump are well-known – ongoing hemorrhaging in the financials and what has tended to feel like horizonless gains for oil. Yesterday’s break past $143 for oil prices was met with a swift pullback on suggestion that the U.S. dollar might be nearing the end of its catastrophic ebb against other currencies, and lower U.S. demand materializing. The pullback was quickly backtalked with troubling tensions between Israel and Iran, news out of OPEC of a record high in the daily average oil price, and the near-ish advent of hurricane season. So it was against this manifold backdrop that we found the Energy Select Sector SPDR .52% high at $88.91 and trading on volume of more than 147,000 lots to rank it handily among the top -10 most active tickers on our platform. Early action showed traders looking for a new break of the $91.16 52-week high by August 16, expressing this view via 90-strike calls which traded for $3.26. Any substantial positions for a pullback in oil look to have settled on the September contract, where we picked up a 20,000-lot put spread between strikes 75 and 85. Here it looks as though the 85-strike puts were bought for $4 while the lower strike was sold for $1.37. A third leg of this trade appeared in September 95 calls, where the 20,000 lots traded to the middle of the market at $2.70, which may have been used as a funding mechanism for the long put spread.

AKS - This morning’s news out of Tokyo that leading Japanese steelmakers including Nippon Steel had agreed to a near doubling in the price of Australian iron ore in negotiations with Rio Tinto had a deleterious effect on other steelmakers in US options trading. Shares in AK Steel Holding Group closed off more than $5 (8%) from yesterday’s close at $63.36, but option traders are flocking to the counterintuitive call side, sending call volume to a 2-week high. At present we see more than 4 times as many calls trading as puts amid what looks like heavy call spread activity between strikes 70 and 75, and outright buying at the out-of-the-money 80 strike call, where the equivalent of more than a third of the open interest is in play.

COF - Capital One Financial shares gained 5.6% to $40.14 after the stock was raised to “neutral” from “sell” by analysts at UBS. Capital One shares have shed 17% of their value this year, and fully half their market cap looking at the 52-week rear view. But investors’ discomfort with its undiminishable exposure to the shaky auto and home loan sectors is clear from the fact that implied volatility weighs in a full 21 percentage points higher than the historic reading – that’s 72.8% versus 54.2% according to our data – suggesting more than a third additional price risk being factored into its option premiums. This disparity has remained more or less constant since early June. On the options front, its 35,000 active lots qualified Capital One for our scan of top-50 most active options. At least one trader took a contrarian tack via a 5,000-lot out-of-the-money put spread in the August series at strikes 30 and 35. It looks here as though the trader sold the lower strike puts for $1.20 against the purchase of 35-strike puts for $2.55, entering with a $1.35 debit (which also represents the maximum capital at risk for this trader) a transaction that first breaks even for the trader at $33.65 – that’s 13% more downside from current levels. Another 10,000-lot transaction in January ’09 $50 calls looked to us like covered call selling, with the trader taking in a $3 credit per contract with the proviso that he or she will hand over Capital One shares at $50 if exercised on the call. Current premiums suggest slightly better than 1-in-3 odds of a January exercise on that bet.

MAT – Yesterday we noted an increase in January call volume in one very conspicuous consumer discretionary company, Barbie maker Mattel as implied volatility remained high, pending a ruling in its catty court infringement case against the maker of Bratz dolls. Implied volatility remains at that consistent elevation – ticking in at 47% against a 29.6% historic reading on the stock – as shares traded .82% lower at $16.98. What’s notable about today’s action, which has culminated in an increase in option trading volume to 2.5 times the normal level, is that some option traders are playing the opposite side of the Mattel story, buying fresh long positions in October 15 puts for 75 cents apiece that imply a more than $2 drop below Mattel’s 52-week low of $16.42. Shares are within a dollar of that low right now, and it looks like the trade du jour favors recessionary pressures pulling the hair of America’s princess a lot harder than a Bratz doll ever could.

XLY- In other news out of the consumer discretionary space, we registered triple the normal level of option activity in the Consumer Discretionary Select Sector SPDR, an ETF weighted with the kind of S&P consumer favorites such as Walt Disney, Time Warner, Target, and Nike that are likely to blister badly as consumers swelter under hot prices for necessities like food and gasoline. Shares in the closed-end fund closed 1.3% lower at $28.12, setting a new 52-week low, and it looks like option traders are bracing for 42% more potential risk to its share price over the coming month. The action we registered today appeared in the form of call buying at the August 31 strike at 21 cents per contract, which looks to us like a protective hedge against a short in the whole ETF.

GD- One day after news that it won a $3.1 billion Air Force contract for IT support and a $16.5 million delivery order from the U.S. Army to expand the technology infrastructure at Fort Meade, shares in defense contractor General Dynamics closed .29% lower at $83.61. In keeping with the tepid response among traders, the 4-fold increase in option trading volume we registered on our platform by mid-afternoon was found not in baldly directional trades, but in long collar activity in the November contract. Here it seems that the trader bought November 80-strike puts at $4.30, funding part of the purchase with the sale of 95-strike calls for $1.60. All else being equal, this is an indicator of bullish sentiment because the trader likes General Dynamic stock enough to hold it long – but he’s nervous enough to protect the position from downside erosion by buying a protective put, and the short call at the other end of the collar essentially functions as a covered call at which he must relinquish his stock position if shares break higher. General Dynamics shares have traded as high as $94.78 over the past 52-weeks (a level reached in December), making that price level not at all out of reach.

RTN- This wasn’t the only defense sector play trading on unseemly volumes. Shares in Raytheon rose 3% to $57.57 as we registered an increase in option trading volume to 4.3 times the normal level, firmly situation in out-of-the-money calls at the November 65 strike. These traded on volume nearly triple the open interest at $1.05 per contract, and may represent covered-call writers or buyers betting on 15% upside for Raytheon shares by November. The $65 level is not unknown territory for this stock, having traded at that level as recently as May.

HRB- One day after posting a profit that piggybacked on dollar weakness, shares in tax preparer H&R Block closed 3.8% lower at $20.57, but we noticed a deferred uptick in option volume to 4 times the normal average that suggested some wary investors not putting much store in the upside thesis. Heavy volume today is noted in July 20 puts, where roughly half the 21,000-strong open interest is in play, possibly taking off a large position at that strike and entering a fresh 20,000-lot position at the same put strike in October, where the $1.65 premium otherwise requires about a 14% decline for H&R Block shares by October. Implied volatility at 44% remains elevated above the 38.5% historic average.

Oil is at $142.50.

As I said yesterday, what do you expect to happen when a tank of gas costs $70?  We were hoping for some relief but we are not getting it.  Every sell-off on the NYMEX, like the one yesterday that dropped oil back below $140 just 5 minutes before the close, is met by an after-hours pump that takes it back up.  Congress is on vacation and the speculators are going wild, driving the prices to new records.  Note the spikes in the price of oil, EVERY SINGLE DAY as we approach the close at 2:35.  Note that 75% of the week’s gains come in pre-market trading while only 1 day in the past 4 has had a close that was higher than the open - yet oil climbed $4 in 4 days!

I mentioned last night that Bush debased our currency further yesterday, taking advantage of Congress’ recess to authorize a $163Bn war spending program and to postpone a Democratic proposal to reign in Medicade costs that had broad bi-partisan support and was due to be implemented today.  All told, those two acts alone raised our 2009 (starts today) budget deficit by over $200Bn, giving us a whopping $600Bn shortfall for the year.  This is causing foreign investors to throw in the towel on America pre-market and our stocks are in free-fall this morning.

On the banking front, LEH adamantly denies the rumors that knocked their stock down 11% yesterday and 20% since they were floated last Wednesday, which also drove the whole financial sector down another leg.  LEH is, in fact, investing $3Bn in small hedge funds and is attempting to do business as usual even as the hyenas circle around them.  As with BSC, it doesn’t have to be true to kill the company and a crisis of confidence can force them to sell.

The Nikkei had another wild up and down day and, once again, ended up going nowhere at 13,463.  The Hang Seng was closed for a holiday but that didn’t stop the Shanghai from falling another 3%, down to 287 now while India had another nasty 500-point sell-off (3.7%) and finished below 13,000 for the first time since last April.  Banks in China were trading limit down on expectations that the PBOC will raise rates to fight inflation and the property market pulled back as DIS denied rumors which have been driving that segment that they will be building a theme park in Shanghai.  Japan’s manufacturers’ confidence is shot due to high oil prices.

It was Europe that tipped the morning markets as very poor manufacturing data combined with a 6% fall in UBS dragged the markets down to the 2.5% rule across the board.  UBS bowed to pressure and adopted new corporate-governance rules and changed their board but that isn’t stopping the US Justice department from attempting to force the bank to turn over the names of US clients who are involved in a tax shelter scandal run by UBS.

The U.K. manufacturing index slumped to 45.8 in June, its lowest level since December 2001.  "We cannot underline enough how appalling these survey findings are for activity in the manufacturing sector — a sector we had hoped would prove one of the more resilient sectors of the U.K. economy," said David Page, an economist at Investec Securities.

Way back at the beginning of the year, I predicted that American Equities would be the "least sucky" place to put our money in what we expected to be a very sucky year but what I should have said is "THE Americas" as this side of the globe has clearly kicked the collective asses of European and Asian markets by a wide margin.  In fact, on a dollar-adjusted basis, our markets only appear to be down 2% to a global investor in Q2.

Does that mean we are flattening out or that we have a long way to fall?  Is sucking less going to be good enough to bring investment dollars back to US equities?  Perhaps, it’s how we pick most of our leaders, so why not our investments…

While this morning is very disappointing already, the real question is "will we hold our levels"?  It doesn’t matter what the Dow does because it’s not the same Dow as we measured last year as BAC and CVX have been substituted for MO and HON.  MO used to be an anchor for the Dow and would typically outperform in a down market.  While CVX has posted an 8% gain for the year, BAC has dropped over 40%, exerting a tremendous drag on the index.

Other Dow zombies include GM - who are down 40% this quarter and off 54% for the year, AIG - 38.8% for the Qtr and 55% for the year, GE - off 28% this Q and the same on the year, C - off 22% this Q and 43% on the year, JPM - who took a 20% hit on the quarter, PFE - off 16% and HD - down 16% for the quarter.  The only "good" stocks on the Dow this whole year are:  WMT - up 18%, IBM - up 9%, CVX - up 6% and CAT - up 2%.  That’s it!  BA had an accident in South Carolina that will delay the Dreamliner and that should knock them to new lows today.  The Dow is off 100 points this morning as of 8:30.

This morning’s move is the move we wanted to have yesterday, a nice morning sell-off to close out the quarter, giving us a final flush to buy into.  We didn’t get it then and I have to say I’m undercovered today, especially after taking a chance on Apple into yesterday’s close.  We will get many retests this morning, including Apple at the $165 line and it’s going to be very hard to get a good recovery with the market closed this Friday and Thursday being a 1/2 session so I suppose we’ll have to do a little capitulating if we can’t hold our 20% levels from Thursday’s Big Chart.

 I will be most concerned with the Nasdaq holding 2,289, the Russell holding 684 and the AMEX holding 2,230 as they have been holding us up for the quarter.  The Dow finished yesterday just below the 11,354 20% line and the S&P has cushion to 1,261 before hitting that mark.  The NYSE has the most breathing room, with a 20% level at 8,310 but that can break too as we are being subjected to the same old noise about:  Recession, Iran, The Banks, Commodities, Inflation, The Auto Industry, Unemployment…  All the things that were bothering us since last year, when I ran this picture with the Dow at 14,000.

As we sit here at 11,200, with the media treating everything old like it’s new again, I have to say the only variable that has really changed is oil, which was "only" $80 at the time.  A 50% increase in the price of oil has sent the industrials tumbling 20% since then and if we are going to continue to have oil punched up $2.50 a barrel between one day’s close at the NYMEX to the next day’s open, then how can we ever expect to recover?

Following recent correspondence with one of our members regarding the methodology behind adjusting bull put spreads, we thought we might use today’s relative calm in the markets to talk strategy; specifically bull put strategy adjustments!

Bull put spreads are popular among option traders because they can profit in multiple directions and use time-decay to great effect.  Out-of-the-money bull put spreads can profit when stocks are flat, rise higher and even pull back slightly.  But what about sharp declines?  With the overall markets in a bearish funk, many out-of-the-money bull put spreads placed recently may now be in jeopardy of turning into in-the-money bull put spreads.  And holding an in-the-money bull put spread means risking short put assignment!

As we mentioned previously, we refused to buy into the Dow breakout chatter around the 13,000 mark and have maintained healthy cash reserves during this most recent decline.  With cash on hand and many stocks dropping to very attractive valuation levels, we still don’t wish to ‘catch any falling knives’ by purchasing stocks outright, but we are becoming increasingly vigilant in scanning for stocks that we would be happy owning at these or lower levels.  And the bull put strategy can assist us in realizing those objectives.

Once a stock has been found and a bull put entered, the goal is for the bull put to expire worthless.  But if the stock drops below the short put strike price, is it absolutely necessary to purchase the stock via assignment of the short put?

Not necessarily!  Alternative adjustments exist which are perhaps more attractive and enable us to realize a number of objectives.  And what are those objectives?  Well, when taking assignment of a fundamentally solid stock, the expectation is that short-term weakness will be replaced by long-term strength over time.  So, even if a short-term bull put runs into trouble, the conversion to a long-term stock position can lead to fabulous profits when direction and sentiment change - as they inevitably do, even if it doesn’t feel like it sometimes! 

For those who are not attracted to the possibility of owning stock and incurring the associated capital obligations, lower risk alternatives are possible!  Let’s use the New York Stock Exchange Euronext (NYX) to highlight one possibility.

We’ll consider a bull put example using ‘easy’ figures to demonstrate the alternative adjustment.  First, we will consider a July $50/$55 bull put spread on NYX was initiated at some point in the past.  Further, we will assume that it is believed the stock has long-term appreciation potential in spite of the negative short-term sentiment.

And we will assume the following positions comprised a bull put spread that had been opened in the recent past.

Sold to open July $55 short put (credit $2.00)

Bought to open July $50 long put (debit $1.00)

Overall net credit = $1.00 per share.

Overall maximum risk = $4.00 per share

As of today’s close, NYX finished down $1.45 to $50.66 per share.  So, the bull put spread is almost completely in-the-money.  As expiration approaches for July, extrinsic value on the short option diminishes due to time-decay.  As a result, the risk of assignment increases.  

With the stock down, most traders would panic and take a loss by closing the bull put spread.  This would constitute buying to close the July 55 short put for $5.10 and selling to close the July 50 long put for $1.84, resulting in a cost of $3.26.  Because $1.00 of credit was received at trade entry and it costs $3.26 to close out the bull put spread, a loss of $2.26 results. 

But if it is believed the stock will rebound eventually, the bull put spread can be rolled out further in time.  If the short option has more time value, its assignment risk is generally considered to diminish.  Let’s consider the August 55 short put, which offers $6 of credit and the August 50 long put that costs $3.25.  The net credit for the August bull put spread would be $2.75. 

By rolling the July bull put spread to the August bull put spread, a tradeoff occurs.  The advantage of the roll is that assignment risk decreases and hence the obligation to commit increased capital to the trade diminishes.  For traders who would be unwilling to commit capital, it means taking a short-term loss is replaced by committing to a longer-term trade.  Instead of requiring the stock to rise up to the strike 55 level by July’s expiration in order for the July bull put to expire worthless, the stock now has an extra month in which it can rebound higher.  The disadvantage is that the net result of closing the July bull put and rolling to the August bull put is the Net Credit diminishes to $0.49 and hence the risk increases to $4.51.

But what if you wanted to increase the return and reduce the risk compared to the August bull put spread shown.  Is that possible?  Certainly!  Instead of choosing strike prices at 55 and 50 for the short put and long put respectively, strike prices at 60 and 55 could be chosen for the same options. 

By selling to open the August strike 60 short put, a credit of $9.90 could be generated.  And by buying to open the August strike 55 long put, a cost of $6.15 would be incurred.  The net credit overall would be $3.75. 

So, rolling from the losing July bull put spread to the August bull put spread would mean taking in a net credit of $1.49 while incurring a risk of $3.51.  Again advantages and disadvantages exists.  The advantages are obvious; the risk is reduced and the reward is increased.  The sacrifice for the more attractive reward to risk ratio is the requirement placed on the stock to rise higher.  As opposed to the 55/50 bull put spread expiring worthless when the stock sits above $55 per share, the stock must now rise above $60 per share before the 60/55 bull put spread expires worthless.

Does any catalyst exist for the stock to rise above $60 per share?  One possibility is the company’s August earnings report.  If the stock does rise higher, the bull put spread could potentially expire worthless, thereby producing a greater gain than had the original July bull put spread expired worthless.  And if the stock were to drop substantially lower, a reduced loss would be incurred than had the July bull put been simply closed for a loss!

Keeping winning options open that also minimize risk is a key to long-term success.  Make sure you are practising winning strategies too!  It’s our mission to teach such winning methods at Stock and Option Trades!

Make it a great Tuesday!!

The Stock & Option Trades Team