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Carter’s Earnings Cancel Sends Implied Options Volatility Skywards

Today’s tickers: CRI, RDC, XL, VIX, XHB, XRX, EFA, WYNN, BIDU & XHB

CRI – Carter’s Inc. – The more than 20,500 option contracts exchanged thus far today on the children’s apparel company trumps existing open interest of just 3,342 lots by a factor of 6. Shares of Carter’s are suffering significant erosion after the firm announced plans to delay its third-quarter earnings release, originally scheduled for this evening, perhaps until November 12, 2009. News of the postponement sent shares tumbling 25.5% lower to $21.16. Investor uncertainty jumped through the roof as evidenced by the massive 66% rise in option implied volatility this morning to an intraday high of 90%. Bullish investors took advantage of today’s declines by trading near-term call options. One trader put on a ratio call spread by purchasing 1,000 calls at the in-the-money November 20 strike for 2.30 apiece, and by selling 2,000 calls at the higher November 25 strike for 55 pennies each. The net cost of buying the calls is reduced to 1.20 per contract. The effective breakeven price of $21.20 on the transaction allows the investor to profit by expiration in November if shares of CRI rise at least 4 cents. Maximum potential profits of 3.80 per contract are available if the stock recovers up to $25.00. Losses would begin to accumulate if any rally lifted the share price above $28.80.

RDC – Rowan Companies, Inc. – Option traders scooped up put options on the provider of contract drilling services while shares slumped 2.75% to $24.90. The January 2010 22.5 strike had at least 1,400 puts purchased for an average premium of 1.16 apiece. The now in-the-money January 25 strike attracted traders who picked up 1,300 puts for about 2.15 each. Bearish sentiment spread to the April contract where another 2,000 puts were coveted at the April 22.5 strike for 2.02 a-pop. Finally, the most action took place at the in-the-money April 25 strike where 9,800 puts were purchased for an average of 3.18 each. Perhaps put-buying investors are aiming to protect the value of long positions in the underlying. Otherwise, traders placing bearish bets on RDC hope to accumulate profits on further share price weakness over the next several months.

XL – XL Capital Ltd. – Bullish investors took aim at XL Capital put options in the January contract this afternoon. Shares of XL are slightly higher by less than 0.25% to stand at the current price of $16.68. Traders appear to have sold approximately 20,000 puts at the January 16 strike for a premium of 1.10 apiece. XL-optimists retain the full premium received on the sale as long as shares remain above $16.00 through expiration in January. The premium acts as a buffer in case shares in fact decline beneath the strike price by expiration. If the put options land in-the-money, short sellers may have an equivalent number of shares of the underlying stock put to them at $16.00 apiece. Investors will experience losses if shares fall through the effective breakeven price of $14.90.

VIX – CBOE Volatility index – Monday’s leap in the reading of Wall Street’s fear gauge was accompanied by one of those occasions when investors were left flat-footed during the trading day as stocks flashed from green to red. It was highly reminiscent of the trading pattern in 2008 and earlier this year when, try as they might, investors couldn’t shake off the recession blues no matter how economists tried to spin data points. Monday’s 10% rise in the Vix has been followed today by a further 0.5% rise to 24.43 only one week after the market volatility reading tried to dip below 20, effectively wiping risk aversion off the radar altogether. Today, however, one option investor appears to be looking for a substantial return to volatile sessions and sold at-the-money put options to back his bet that the Vix will return to a mid-30 reading by the end of 2009. Using the December contract some 24,000 call options at the 35 strike were bought for 79 cents, partially funded by the sale of almost 7,500 put options expiring at the same time for a higher 1.90 premium. One possible explanation for the actions of this investor, who expects the value of the puts to fall and the price of the calls to increase, is Tuesday’s return to deteriorating consumer confidence. With more than two-thirds of output origination from consumers, this trader is concerned about further market weakness ahead.

XHB – SPDR S&P Homebuilders ETF – Positive news regarding U.S. home prices may have inspired one investor to initiate a long butterfly spread in the November contract. Shares of the homebuilders exchange-traded fund are relatively flat at $14.80. The S&P/Case-Shiller home-price index gained 1% from the previous month and the number of U.S. building permits issued in the month of September was revised up to 0.575 million units from previous estimates of 0.573 million units. Economic data aside, the butterfly spread initiated this morning is a bullish sign for the XHB. The butterfly was constructed through the purchase of 10,000 calls at the November 15 strike for 54 cents each [wing 1], and the purchase of 10,000 calls at the higher November 17 strike for 8 pennies apiece [wing 2]. The central November 16 strike had 20,000 calls sold for 21 cents per contract [body]. The net cost of the transaction amounts to 20 cents per contract. The nature of the butterfly strategy indicates the investor expects shares to settle at $16.00 by expiration next month. Shares must rise approximately 8% from the current price to $16.00 in order for the trader to reel in maximum gains of 80 cents per contract. The parameters of the trade are such that the investor may lose no more than 20 cents – the cost of the spread – but stands to gain 80 cents. The investor has wisely devised a strategy with a risk-reward ratio of 1-to-4.

XRX – Xerox Corp. – Option bulls trampled the December contract for Xerox calls despite the 0.75% decline in shares to $7.71. The purchase of about 15,400 calls at the December 9.0 strike for 15 cents apiece suggests investors expect shares of XRX to rebound by the end of 2009. Call-buyers at this strike will profit by expiration if shares rally approximately 19% to surpass the breakeven point at $9.15. The rise in demand for calls has perhaps contributed to the 10% rise in option implied volatility on the stock to the current reading of 43%.

EFA – iShares MSCI EAFE Index ETF – Shares of the exchange-traded fund representing stocks from Europe, Australasia and the Far East, edged slightly higher today by less than 0.25% to $55.40. We observed bearish activity in the near-term November contract despite modest gains in EFA shares. It appears one investor established a ratio put spread by purchasing 5,000 puts at the November 55 strike for an average premium of 1.33 apiece, and by selling 10,000 puts at the lower November 50 strike for 25 cents each. The net cost of the pessimistic play amounts to 83 cents per contract. The transaction is likely the work of an investor holding a long position in the underlying stock. If this is the case, the trader purchased downside protection that will kick in if shares decline beneath the breakeven point at $54.17 by November’s expiration day.

WYNN – Wynn Resorts Limited – The owner and operator of casino resorts posted third-quarter earnings per share of 33 cents – a 33% decline in net income – sending shares 10% lower to $56.75. Wynn Resorts has now reported declines in profit for two consecutive quarters. WYNN’s lackluster earnings is weighing heavily on other casino operators such as Las Vegas Sands (-7.5% to $14.88) and MGM Mirage (-8% to $10.08) as of 10:30 am (EDT). Investors have exchanged 22,000 option contracts on WYNN.

BIDU – Baidu, Inc. – Shares of the Chinese language internet search provider are trading 13% lower as of 10:15 am (EDT) to stand at $376.56. The decline in shares seems to contradict the firm’s better-than-expected third-quarter earnings of $2.16 per share. However, investors were disappointed by Baidu’s forecast for fourth-quarter revenue, which the firm says will likely decline as they transition to a new internet advertising technology. Shares dropped as much as 18% to $355.71 while implied volatility tumbled 16% to 44% following earnings. Approximately 50,000 option contracts – 32% of existing open interest – changed hands by 10:30 am (EDT).

XHB – SPDR S&P Homebuilders ETF – A butterfly spread unfurled its wings in the November contract on the homebuilders ETF within the first 15 minutes of the trading session. Shares of the XHB are lower by 1.5% to $14.58. Perhaps the investor responsible for the trade is expecting shares to rebound by expiration next month. Stay tuned for a more in depth analysis of this transaction…


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