Options Expiration Expectations

Options Expiration Expectations Could Upset the Week Ahead

Wall Street: A Low Vix Could Spell Opportunity For Bulls!

by Ian Harvey

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July 16, 2012

Introduction

Stocks spent most of last week wallowing in the red, embarking on their longest losing streak since mid-May. However, the bulls came back with a vengeance on Friday, as in-line economic data from China and solid earnings from the banking sector pushed the major market indexes back near breakeven for the week.

Against this backdrop, the collective expectations on Wall Street are of interest, as well as technical levels being on the radar as options expiration approaches.

Levels to Watch This Options Expiration

".....The S&P 500 Index (SPX – 1,354.68) comes into the week below resistance at 1,362.16 -- near its 2011 high, its April low, and a 61.8% Fibonacci retracement of the April 2012 high and last month's low.
Situated just below the 1,362 area is the 80-day moving average at 1,358, which capped a mid-June rally. The SPX moved through these resistance areas early last week, but failed to close the week above these levels. Should a pullback from resistance continue -- the 1,333 area -- site of the March 2009 "double low" -- could act as support. "

- Stock Market Technical's Before Earnings Begin - July 09, 2012

"Two major banks slashed their U.S. growth forecasts for the second quarter after trade and inventory data for May confirmed signs of the further slowdown that many economists have feared ... Both Deutsche Bank and Barclays slashed their second-quarter forecasts by a full percentage point ... Barclays cut its second-quarter forecast to 1.5% from 2.5%."
- The Wall Street Journal, July 11, 2012

"J.P. Morgan also noted loan demand is doing well. The bank made about $10 billion worth of small-business loans in the second quarter, 35% more than a year ago and more than double the first-quarter level. Total loans rose 5%, underscoring how the feared slowing economy isn't impacting demand for business loans at J.P. Morgan."
- The Wall Street Journal, July 13, 2012

"Visa (V) gets some good news as JPMorgan Chase (JPM) reports acceleration in credit-card spending in 2Q. JPM, the largest credit-card issuer based on outstanding loans, said spending on its cards increased 12% year-over-year to $96B, which also was up 10% from 1Q. JPM is the largest issuer of V credit-cards, so an increase in use means more transaction volume for V. Despite higher spending, actual outstanding loans declined 2% to $125.2B, which means that while customers are spending more on their cards, they're not carrying balances as much month to month."
- Dow Jones Newswires, July 13, 2012

Equities got off to a rough start last week, as Barclays, Deutsche Bank, and Goldman Sachs all slashed their respective second-quarter gross domestic product (GDP) forecasts by an eye-opening full percentage point. Stocks pulled back, but the Standard & Poor's 500 Index (SPX - 1,356.78) found support in the 1,333 area on Wednesday, retreated below this level briefly on Thursday morning, and then recovered to close back above the March 2009 "double low" by Thursday's close.

July Options Expiration Week

Going back to early June, the SPX has grinded higher in a very choppy fashion. With the SPX little changed last week, we enter July expiration week staring at resistance from the 2011 calendar-year high just above current levels, while support at 1,333 -- double the March 2009 low and a 38.2% retracement of the June low and July high -- resides just below.

The Immediate Effects

Implications for the immediate term were the slashing of GDP forecasts by at least three major banks. After GDP forecasts were cut, JPMorgan Chase (JPM - 36.07) earnings displayed what could be a pretty decent growth story. For example, engines of the economy -- the consumer and small business -- seem to be in better shape than headlines suggest, as JPM reported accelerated credit-card spending both year-over-year and quarter-over-quarter, even as consumers carried less balances month to month. Moreover, loans to small businesses, usually a driver of employment growth, rose 35% year-over-year, and doubled loans in the first quarter.

“GDP or Gross Domestic Product” is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

GDP = C + G + I + NX

where:
"C" is equal to all private consumption, or consumer spending, in a nation's economy
"G" is the sum of government spending
"I" is the sum of all the country's businesses spending on capital
"NX" is the nation's total net exports, calculated as total exports minus total imports.
(NX = Exports - Imports)

GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. Critics of using GDP as an economic measure say the statistic does not take into account the underground economy - transactions that, for whatever reason, are not reported to the government. Others say that GDP is not intended to gauge material well-being, but serves as a measure of a nation's productivity, which is unrelated.

This may allude to the fact that perhaps the slowing in economic growth is not as bad as advertised. Time will tell, but judging by the resilient stock market, there might be something to this. At the very least, a lower-expectation environment should be viewed as a good thing for stock investors. In other words, if economic growth indeed meets the lowered expectations, it will not come as a major negative shock, implying selling would be muted relative to a disappointing economic report amid higher expectations.


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TOP OPTIONS TRADES SINCE JUNE 01, 2012

TRADE GAIN TRADE GAIN
HLF July 47.50 Calls 53% APPL Aug 650 Calls 67%
DLTR Aug 110 Calls 32% UIS Oct 17 Calls 79%
HSY Aug 70 Calls 56% TSO Nov 25 Calls 54%
NKE Oct 92.50 Calls 49% HLF July 47.50 Calls (again) 38%

July Options Expiration Horizon

Turning back to what lies ahead on the immediate horizon, this week brings the options expiration for July. As you can see from the chart of SPDR S&P 500 ETF (ARCA: SPY - 135.75) open interest, option sellers would love to see the SPY close above 135.00 and below 137.00, which would allow them to pocket the premiums collected from the sales of these options. Therefore, these are levels that could serve as support and resistance before options expiration.

The 137 strike would correspond to the 1,370 level on the SPX, which is where the SPX recently ran into resistance, as discussed above. The risk during options expiration week is a catalyst that would suddenly send stocks reeling through major put strikes. Heavily populated put strikes below the market price can act as magnets if heavy selling begins, as those that sold the puts to open must short more and more equity futures to maintain a neutral position. This is known as delta-hedging, and can magnify selling during options expiration week, as we saw in May. For example, if the SPY trades below heavy put open interest at the 132 strike this week, it could set the stage for a continued downward move -- through additional layers of put open interest and all the way to the 128 strike, at which point the put open interest drops off considerably and the "magnet effect" lessens.

Further Articles Relating to the Week Ahead

1. The Week Ahead in the Stock Market - July 16, 2012

2. The Economy and Earnings in the Week Ahead – July 16, 2012

3. The Past Week Stock Market Results – July 16, 2012

4. The Major ETFs in the Week Ahead – July 16, 2012

5. VIX and Historical Volatility - Market Indicator for the Week Ahead – July 16, 2012


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