Options traders were heavy betters on a further decline in the market today.  Of particular interest was one large trade in VIX options which is looking for further market weakness ahead:

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.

Some positive news on the housing front has investors betting on the homebuilders.  Not only were the Case/Shiller numbers strong, but news of the tax credit extension had investors snatching up call options in the homebuilders ETF:

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.

• Goldman Sachs also issued an extensive note today on the banks.  They continue to favor large banks over regional and smaller banks.  In particular, they like Bank of America, JP Morgan, PNC and Capital One.   The firm also raised their price target on PNC from $38 to $54.

Source: IB