MorningWord 1/31/12: VIX Hedging

by Dan January 31, 2012 8:52 am • Commentary

MorningWord 1/31/12: Yesterday’s opening blip, down ~1% was just that, a blip as the SPX spent most of the rest of the day drifting back towards unchanged.  Investors fears of the Euro Summit not producing the desired results have quickly been quelled by the (near) completed treaty that will place sanctions on debtor nations that don’t keep to the plan……The DAX is up a little more than 1% on the kind of good news, and our futures are up 45 bps on what appears to be an unconvinced rally.  

Yesterday on “quick hits” I mentioned that I am near laying into this market on the short side and if today’s opening doesn’t hold I will look to press the short.  The SPX held 1300 yesterday and very frankly showed some impressive resilience, but again on light volume and if there is ever a reason for sellers to take profits we could see a fairly sharp decline in a short period of time.

On another note, for those of you who are long stocks and are looking for a sort of out of the money disaster hedge in the near term, you could consider out of the money VIX Call Butterflys in effort to spend a small amount of premium to offer a decent bit of protection if the VIX spiked….

Last night on Fast Money I quickly laid out the strategy while offering a couple of caveats….first this strategy is intended to lose money, it is to act as a hedge in the event of a vol spike so by its structure has a low probability of being in the money……I guess my point is, if you are long stocks you want them to go up, but in the event we see a quick sell off this structure could offer some cheap protection.

Here was the trade that I laid out last night on Fast, with the market’s up opening, the VIX will be down and this will be cheaper, but I will tell that when trading VIX options always place your bids or offers inside the market, they will likely get filled rather than paying full bid ask.

VIX (19.42) Buy Mar 25/30/35 Call Fly for .40

-Buy 1 Mar 25 call for 2.10

-Sell 2 Mar 30 calls for a total of 2.50 (1.25 each)

-Buy 1 Mar 35 call for .80

Break-Even On March 21st Expiration (note that VIX options expire on different day than equity options):

Profits btwn 25.40 and 30, make up to 4.60, profits trail off btwn 30 and 34.60, with max gain at 30 of 4.60

Lose up to .40 btwn 25 and 25.40 and 34.50 and 35, with max loss of .40 below 25 and above 35.

VIX Call Butterflies as a Hedge against a long stock portfolio on Fast Money 1/30/12

MorningWord 1/30/12: As I write at 9am, the S&P futures are down about 90bps, marking one of the lowest pre-market readings of the year and also signaling what will likely be the first print for the SPX below 1300 since closing above that level (for the first time since late July) on Jan 18th.  On a week that is expected to see some news out of Europe with today’s start to a Summit in Brussels on Greek bailout, the markets will need to find support in the 1290/1300 level if they intend to keep the uptrend-line intact.

SPX daily chart since Nov 30th 2011 from Bloomberg LP


Aside from Europe, there will be a ton of economic data in the U.S. this week ranging housing, manufacturing, consumer confidence and then of course jobs…..this coupled with the back half of earnings season could see the market action look a bit like “buy the rumor, sell the news” for the January effect.  At current levels in equity market’s like ours up ~4.5% and the DAX up a bout 9% ytd, I think it is safe to say that there is a lot of good news priced into stocks at these levels, especially when you consider that a lot of the issues that plagued us last year have not exactly been fixed yet.

I remain cautiously positioned, and will look to short rallies as I am looking for at least a 30-50% re-tracement of the 2012 ytd rally.   As for this morning, I would expect to see the market try to rally after the almost 1% down opening and I will look to short that first rally buy either buying SDS or possibly looking to buy SPY weekly Puts, again, on a rally, I don’t press down openings on little news.  As many of you know I had begin to position for this last week, by closing longs like GS and adding a short (stock) in MSFT.  I want to short names that I believe benefited from dumb mutual fund buying in the beginning of the year (like MSFT) and look to add longs that are likely to continue to outperform after a little bit of a pullback (like GS, heck I would even buy BAC back below $6.50).

MorningWord 1/27/12: I am gonna go out on a limb and suggest that Mr. Bernanke had a sneak peak at this morning’s Q4 GDP reading that came in weaker than expected (forecast for 3%, actual 2.8%) prior to announcing on Wednesday that the FOMC would keep interests rates near zero till some time in late 2014.  Statistically the miss isn’t a huge deal, but it is one of the first pieces of significant economic data that I can remember this year that has disappointed expectations.

The S&P futures have dipped about 70bps on the news on what appears to be very light trading.  When you take a look of the 10 day chart of the SPX (below), since breaking above the psychologically important 1300 level on Jan 13th for the first time since late July, the index has done it’s best to base about that level and appeared to be ready to make a sort of blow-off top towards last years highs, or at least to 1350 resistance.

10 day SPX chart from Bloomberg LP


Yesterday’s reversal from almost 6 month highs could be the sign that a lot of the good economic and earnings news that we have had so far this year was in the market, up about 5% ytd (as of yesterday’s close).  I for one have been skeptical of the rally and have been waiting for signs of the rally getting narrower on declining volume.

AAPL is a name that I usually keep an eye on as it is a decent sentiment indicator in my mind for how the big money is thinking. There are 2 main reasons for this, as one of the few largest market cap company’s in the world, this is not a name that hedge funds can really push around (so there has to be a level of commitment by large holders to get this thing moving, as we saw on Wednesday), and second it is such a widely held name among retail, whether they own it outright or not, as it makes up a large percentage of many domestic mutual funds and index etfs…..

Following AAPL’s blowout Q1 reported Tuesday, I really wanted to see the stock get a bit overdone on its runaway break-out to all time highs as I felt strongly that any holder who had significant gains in the name over the last year or 2 (it would almost be impossible not to if you bought it at any time prior than Tuesday) would have to take some profits….Well as the 5 day chart of AAPL (below) shows that the opening tick Wednesday morn at about $454, was the high over the last 2 days.

5 day AAPL chart from Bloomberg LP


Now AAPL’s 2% sell off since Wednesday’s opening is by no means scary, but I would expect the stock to fill in a bit of the earnings gap and look to consolidate before the stock can attempt to rally into the expected iPad3 launch in late March or early April.

As for today, I would look for the SPX to hold 1310 which is essentially the level in which we have based for the last week and a half and then the next real level of support is about 1300.  I have been waiting for a little bit of a pull back and if we rally off the down opening this morning, I will look to fade it…..


MorningWord 1/26/12: If the Fed’s intention by signalling that interest rates would remain low until late 2014 (previous target was sometime 2013) was to encourage investors to buy riskier assets, then they certainly got things going in the right direction yesterday.  The SPX had an almost 1.5% reversal off of the morning lows to close a tad off of the highs, while Gold had a massive reversal of about 4%, with gains continuing into this morning.  

[caption id="attachment_8323" align="aligncenter" width="300" caption="2 day Gold chart From Bloomberg LP"][/caption]


With the SPX at 1326, now only a few % from the May 2011 highs, and up almost 5.5% on the year, it is becoming fairly apparent that the market seems ready to make a little “blow off” top…….meaning a last little push to test some levels not seen since that will cause shorts to climb over each-other to cover.  This move won’t exactly be the most bullish thing for those who are long for the intermediate term, or who bought into the rally yesterday as it will likely be followed (in my humble opinion) by a fairly sharp sell-off.

The chart below is a bit obvious to most, the divergence btwn the SPX and the VIX both hitting levels not seen since the last week of July.  While this relationship could continue to exist for a bit longer, at some point, with equity markets approaching previous highs, and European indices like the DAX up 10.5% ytd (recouping about 2/3’s of last yr’s losses), something will have to give.

[caption id="attachment_8324" align="aligncenter" width="300" caption="1 YR VIX vs SPX from Bloomberg LP"][/caption]


I will continue to look for signs that the equity market rally the world over is getting narrower, but for the time being my positioning remains lite from a trading perspective, but will likely start to average into some market shorts in index etfs.

Earnings data continues to be mixed to slightly better which is obviously helping sentiment, but we will get a few broader reads in then next 25 hours about the economy as whole with New Home Sales data expected today at 10am, and GDP and Consumer Confidence tomorrow morning.

The question of earnings beats is interesting to me, because most are coming off of previously lowered estimates….in the case of NFLX for instance, the stock is rallying close to 19% this morning as they beat Q4 and raised Q1, but remember where these estimates came down from just 6 months ago…..listen this move will be great for the Jan/Mar calendar that I bought yesterday, but that doesn’t mean exactly that the move is rational.  On the flip side a stock like SNDK that was about about 65% from the Aug lows, is getting creamed this morning on worse than expected results.  As we head into the back half of earnings season, it will be important to watch how some prior leaders act, as investors digest what amount of good news is in individual stocks.

MorningWord 1/25/12:  If I could barely contain myself in anticipation of AAPL’s fiscal Q1 report yesterday morning then I must be popping out of my seat following the absolutely killer results.  By all accounts, things are firing on all cylinders there, and the soft-patch they saw leading up to the end of their Sept qtr, as they stated was consumers waiting for the 4S.  As many readers know I am a huge fan of the company and their products, but I am not a fan of the cult following the stock has garnered.  I am a bit of a contrarian when it comes to trading so I look for opportunities to trade based merely on price action, when I think a stock  like AAPL (regardless of valuation, balance sheet, product cycle),  is a bit extended on the upside and a bit overdone on the downside.   With the stock up $38 in the pre-market, or about 9%, I would expect traders who were long into the print to take some profits and If I were a long term holder I would probably look to trim up here at all time highs after such an enthusiastic move.

Listen, I know what most of you are thinking, that this is the best company on the face of the earth, for that matter the best the world has ever known, and I get that, but what comes up must come down at some point.  So I know I sound like a broken record, but when everyone is one way, I usually tend to look the other.  Remember I am a trader, so I am not naked short this stock ( I do believe and have said on many times int he last few months you would have to be nuts to),  I look for the best risk/reward relationship in the options market and risk what I willing to do when I take shots getting short exposure in a name like this.  [check back later today, If the move gets a little frothy on the upside I may look to make a short term bearish play that the stock pulls back a few % and finds a little home to base].

AS a personal disclaimer earlier in the week I replaced my iPhone4 with a Samsung Galaxy II S SkyRocket (yes if u can believe it that is what GOOG and Samsung’s name of their iPhone Killer is, Jobs must be rolling over in his grave laughing).  Well the plastic hunk of junk was returned in about 24 hours and then I upgraded finally to the iPhone4S with my new little friend Siri (she helped me pick out my tie for Fast Money tonight, so watch at 5pm on CNBC).   Forget about me upgrading here, the next 12 months will be about the millions upon millions of Chinese Citizens who appear to want iPhones.  I am not changing my tune on AAPL, much like RIMM in the mid part of last decade, when then got outside of North America and opened their available carriers to hundreds worldwide, that’s when the thing absolutely exploded. Well, a lot of that has to be in the stock at current levels, but could be fueling upside for the balance of the year especially as iPhone approaches more than 50% of the company’s revenues.

What A Hunk of Plastic Junk with a very annoying interface

It appears that things can’t get much better at this point, and with AAPL for the last couple years as soon as you thought that, well they do…..I AM NOT A BUYER AT CURRENT LEVELS, I HAVE SAID THIS FOR THE LAST 12 MONTHS IN THIS NAME, IF YOU WANT TO BUY THE STOCK, DO SO ON ONE OF ITS FAIRLY FREQUENT (AT LEAST IN THE LAST YEAR) 10% PLUS SELL OFFS.  I CAN ALMOST BET MY CAT THAT WE WILL GET ONE IN THE NEAR FUTURE.

On another note I don’t think it is a sound investing strategy to buy stocks at all time highs on runaway break-outs, I know I am going to get blasted on the web for these comments, BECAUSE A LOT OF AAPL BULLS FEEL THIS IS SUCH A UNIQUE STORY, AND “THAT IT’S DIFFERENT THIS TIME’, well let me you a little secret, it’s never different, it’s just a mater of time before there is a Jim Jones moment for this cult stock.

By the way, reader Brian K. sent this link to this early December analysis of AAPL’s Dec qtr, and I don’t know who or what they are, but this guy totally nailed the AAPL qtr.  This was picked up by Bullish Cross, again don’t know them either but they also had it right.

Oh, and there is other stuff going on this week… the 2 day FOMC meeting that concludes today.  Markets are likely to be in a holding pattern until the late afternoon rate decision and press conference.

I continue to look for evidence that the ytd rally is getting narrower and narrower at this point earnings are generally coming in better than expected, as of last night something like 50 or 80 S&P 500 company’s had beaten Q4 estimates so far, which I guess is ok, but in most cases those estimates had been lowered at some point in the last few months.  There is no real argument to make that equities don’t act well, but at some point soon there will be a great opportunity to make some $ on a sharp sell off, stay tuned.



MorningWord 1/24/12: Some of you may have some things on your mind today, like a Greek debt deal, or the start of the FOMC’s 2 dayer, or maybe some of you are still mourning the loss of your Niners or Ravens, well I for one care about one thing today, and that’s AAPL’s fiscal Q1 to be reported after the close.  Not to sound like and alarmist, but tonight’s report and the guidance given, and any subtle changes from the way things used to be done under Jobs, will likely set the tone for investor relations in the post-Jobs era for AAPL. There are a few things that are on the tips of large investors tongues that sooner or later will need to be addressed by new CEO Tim Cook, tops on the list, and something that Jobs wasn’t partial too, articulating a plan for their massive and growing cash of hoard.   That won’t likely be answered anytime soon, as most past investor concerns that Jobs shunned won’t be changed for the time being, but what is pressing is to see if AAPL can re-capture the 2 million “lost” units of iPhone in their Q4 that, to be fair, came in lower than aggressive Street consensus and iPads that just seemed to plateau a bit.

AAPL as a stock has become a behemoth of the highest order. With the stock at $427 it has a market cap of about $398 Billion. To put that in perspective, that is double GOOG’s $189billion and more than 30% higher than MSFT’s and IBM‘s market cap of about $250billion & $224billion.

To be a bit of a contrarian, when a company can do no wrong and is trading at all time highs, despite their pristine balance sheet, off the chart growth expectations and rock bottom valuation, I CAN THINK OF NOTHING ELSE THAN SHORTING IT AT ALL TIME HIGHS HEADING INTO A MUCH ANTICIPATED EVENT.  Now I would obviously not bet the farm on this, and if the stock was sitting at all time highs as it was in OCT I would be hard pressed not to do this in a defined risk manner.

The chart below shows the previous 3 all time highs made in July, Sept and then Oct of 2011, all followed by double digit drops in the stock that average about 14% per sell off.  Are we setting up for a similar move where obviously a ton of good news is in the stock and expectations are running fairly hot??

[caption id="attachment_8220" align="aligncenter" width="300" caption="1 YR AAPL chart showing 3 Previous All Time Highs from Bloomberg LP"][/caption]


Many readers know that I feel strongly that the next couple of years for the company and thus the stock are likely to be far more difficult than the last couple……competition is coming from everywhere in the smartphone and tablet space, and while I am still of the mindset that their products are generally superior to most android offerings, and certainly all MSFT and RIMM offerings, at some point these inferior competitors will just try to compete on price and eventually erode AAPL’s margins……

The problem with a structural short in the name is the amazingly bullish factors I listed 2 paragraphs higher, they will soon have $100 billion in cash on their balance sheet with no debt, almost ONE HUNDRED DOLLARS IN CASH IN THE COMING MONTHS, and what appears to be fairly healthy leads in the most rapidly growing segments in all of consumer tech, so timing will be everything.

The implied move in the options market has ticked up a bit to about 4.8% and I feel all the risk is to the downside as we head into the print.  If AAPL blows the doors off iPhone and iPad as many expect in what was a healthy holiday selling season, then the stock goes up. But at some point investors are going to need to take profits as the stock is just now capping a 2 month almost 18% rally from the December lows……throw in a gap opening tomorrow morning in line with the implied move and this stock has gone parabolic.  But if the company disappoints consensus estimates for the second quarter in a row, which would be the first time this has happened since 2003 or 2004.  If that happens you will see a sell off far exceeding the implied move.   Tim Cook will not be able to spin a disappointment the way Jobs would have and this is why while I think there is a higher probability that the qtr is inline to better (coupled with their usual conservative guidance), I think the trade where you get the most bang for your buck is leaning short into the print.

Once we get through tonight’s report the next catalyst will be a March/April iPad3 launch which I expect to be a bit evolutionary and possibly somewhat conciliatory if they introduce a smaller form factor to do battle with the Kindle Fire and other lower priced models.   After that we have a bit of a wait until a dramatically redesigned 4G iPhone in October and what will likely be some Mac refreshes here and there, with a likely really expensive multi-touch iMac on the way.  So there will be a lot of waiting (and hoping for those long the stock) this year to see if the company can continue to make “revolutionary” products rather than the “evolutionary” iPad2, iPhone5 and recent MacAir refreshes.

In the last few weeks I have suggested a couple collars in AAPL to protect longs, on short dated in Feb, and one looking out to July.


MorningWord 1/23/12:  All is really right in the world, the Euro is back above 1.30 vs US dollar, wow who would have thunk it?  I guess it really had become a fairly crowded trade.  European equity markets are up across the board this am, as EU finance heads are meeting today in Brussels for what seems like the 100th summit in so many days to make a plan to deal with Euroland’s debt issues.  The markets are very calm ahead of today’s festivities, as expectations aren’t exactly high, and any results are only likely to kick the can down the road when they finally reach a plan agreed apon by everyone else and then by Z-Germans.  European Sovereign debt seems to be the tell here with the Italian 10 year yield down about 1% from this year’s highs.

Earnings for the most part on this side of the pond, coupled with economic data all seem “less bad” in the new year, and are driving most of the positive sentiment and the talk of re-testing last May’s highs that sit about 4% from current levels…..I am of the mindset that once we get through the bulk of this week’s earnings and we have the FOMC policy update and Bernanke conf call (Wednesday afternoon) in the rear-view mirror that the rally may start to peter-out when investors consider that much of their enthusiasm as it relates to the stock market and the economy are coming from upside to estimates that had been dramatically decreased over the last couple quarters.  Company’s are beating estimates that were raised a year ago and then have been coming down for the last 4 months, same goes for our economic data that swung from overly optimistic in Q2 last year to possibly overly pessimistic over the last couple months.  I often say this about markets, but this pertains to most sentiment related inputs we collectively use to analyse the markets, ” price action tends to overshoot on the upside, just as it does on the downside and vice versa”.  This is exactly what we appear to be doing right now and why many bulls squarely have 1370 in their scopes.   There are plenty of names that appear not to be letting up like INTC, MSFT, BAC and CAT but action from a market leader like GOOG on Friday could be a sign of things to come as investors re-set their expectations for 2012 with almost 5% gains already in the tank.

I read something on Bloomberg this morning that I thought was kind of interesting and helps make this point…..

Divergence between S&P 500 making new high while the number of stocks in the index making new 52- wk highs shrinks may be “early sign that the market is tired,” says Strategas technical analyst Chris Verrone.

• Number of stocks making new 52-wk highs Friday was 126 vs. 215 on Dec. 27, 2011: Verrone

• Sees “lots” or resistance at 1320, 1347, 1357, 1371; sees “healthy” support at 1278, 1257, 1247, 1230; says 150pt trading range “will continue to define trading in the months ahead”: Verrone

Verrone added the following early last week in a Bloomberg story dated Jan 17th;

The stock-market rally has driven short interest to a nine-month low and bearish sentiment close to a six-year low, a sign that few investors may be left to propel further gains.

As for today I think it is important to watch names like MSFT, INTC, IBM, GOOG and of course the banks as they were all big movers on Friday.  AAPL to me will be the main event this week, not because it will be a big mover for the broad market, we know that their market share has little to do with competitive pressures, but much like GOOG a break-down on volume could signal a change in leadership for the market and cause investors to question so of the very crowded trades in the market.