Volatility Sellers Attack UltraShort S&P500 Calls

SDS – ProShares UltraShort S&P 500 ETF – Roughly 50% of the S&P 500 Index rally from August 2010 through early-May has evaporated, with the market meltdown accelerating on the heels of the downgrade of U.S. debt. The VIX spiked to flash-crash levels today, and exceeded 40.95 earlier in the session as U.S. equities tumbled lower. However, barring a repeat of the flash crash or some other unforeseen piece of negative news, it looks like options strategists are positioning for investor fears to ease in the near term. Heavy out-of-the-money call selling on the SDS, an ETF corresponding to twice the inverse of the daily performance of the S&P 500 Index, was likely initiated by traders selling the spike in volatility. Shares in the SDS shot up 7.9% this afternoon to $26.52, the highest since November 2010. Volatility sellers targeted the August $30 strike most aggressively, selling some 45,000 contracts at that strike against paltry previously existing open interest of 1,651 contracts. Investors short the calls pocketed an average premium of $0.43 apiece, which they keep if shares in the SDS fail to rally above $30.00 at expiration. Traders have time on their side and may be able to buy back the calls, even if the S&P 500 Index continues to slide, at an advantageous price as long as volatility comes off in the next couple of weeks. Call selling spread to the August $31 strike, where nearly 10,200 contracts sold for an average premium of $0.32 each. Sellers dominated up at the August $32 and $33 strikes where some 2,600 and 6,100 calls sold for an average premium of $0.26 and $0.21, respectively. Volatility could come off should President Obama, one of the G7 leaders, the IMF, a central banker, or other government leader throw a few crumbs of optimism the market’s way this week to assuage investor fears. Meanwhile, closer-to-the-money call buying, on the other hand, indicates other strategists expect the S&P 500 Index pullback has more room to run in the next couple of weeks. Investors purchased some 12,600 calls at the August $29 strike for an average premium of $0.65 apiece. Bears long the calls profit if shares in the SDS rally another 11.8% to top the average breakeven price of $29.65 by August expiration day.

RIMM – Research in Motion Ltd. – Shares in the Blackberry maker plunged 6.5% to touch a fresh 5-year low of $21.88 this afternoon despite reports Primecap Management Co. doubled its stake in Research in Motion to 26.4 million shares, around 5% of the company’s outstanding equity. News that might have otherwise lifted the Blackberry manufacturer’s shares was overpowered by the global market selloff. One options strategist seems to have prepared for the turmoil this week by taking a large stake in January 2012 contract puts. It looks like the trader originally purchased 36,875 puts at the Jan. 2012 $24 strike last Wednesday for a premium of $3.45 each. The puts are now deep in-the-money, and it appears the investor sold all of the contracts this afternoon at a sharply higher average premium of $4.925 per contract. Net profits on the trade amount to $1.475 per contract. Next, the investor extended bearish sentiment on the stock by purchasing some 49,200 puts at the Jan. 2012 $21 strike for an average premium of $3.325 a-pop. Profits are available on the new put position should RIMM’s shares plummet 19.2% to breach the average breakeven price on the downside at $17.675 at January expiration. Options implied volatility on Research in Motion rose 18.1% to 84.02% by 1:45 pm on the East Coast.

KWK – Quicksilver Resources, Inc. – Better-than-expected second-quarter earnings from oil and natural gas producer Quicksilver Resources offered little protection in a down market reeling from S&P’s downgrade of U.S. debt on top of persistent fears the global economy is slowing. Shares in Quicksilver dropped 17.9% this morning to an intraday- and new 2-year low of $9.65. Options traders populating KWK today are signaling the worst is yet to come. It looks like investors exchanged more than 5,100 in-the-money puts at the September $10 strike against previously existing open interest of just 46 contracts. Most of the put options appear to have been purchased at an average premium of $0.61 a-pop. Put buyers profit if shares in Quicksilver Resources slip beneath the average breakeven point on the downside at $9.39 by expiration day next month. Bearish players also picked up around 300 in-the-money puts at the September $11 strike at a premium of $1.20 apiece during the first half of the session. Options implied volatility on KWK is off its highs off the session, but remains sharply higher by 27.8% to stand at 63.59% as of 11:45 am ET.

XLB – Materials Select Sector SPDR Fund – Investors selling call options on the XLB, an exchange-traded fund that corresponds to the price and yield performance of the Materials Select Sector of the S&P 500 Index, are betting there is little chance of a near-term recovery in the sector. Shares in the XLB dropped 3.85% this afternoon to $33.00 by 1:00 pm in New York trade. Call sellers took to the options market early in the session, selling around 15,000 calls at the August $34 strike for an average premium of $0.62 apiece, against previously existing open interest of just 554 contracts. Investors keep the full amount of premium received as long as shares in the XLB fail to rally above $34.00 at August expiration. Investors short the calls may simply be looking to take advantage of the 14.2% rally in options implied volatility on the fund this afternoon. If volatility pulls back traders could potentially find opportunities to buy back the calls in the next couple of weeks, particularly with time value working in their favor heading into expiration on August 19. Call sellers run the risk of needing to buy back more expensive options in the event of a sudden rally in the materials ETF, or delivering shares in the underlying fund should the calls land in-the-money at expiration.

About Andrew Wilkinson 1023 Articles

Affiliation: Interactive Brokers

Andrew Wilkinson is the senior market analyst at Interactive Brokers Group, where he provides daily commentary and analysis on U.S. equity options trading throughout the trading day. Andrew provides webinars designed to explain option-related trading scenarios covering futures, fixed income, forex and equities.

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