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Implied volatility is falling and some players in the options market are taking advantage of the cheaper premiums to buy portfolio protection. Spyders (SPY) July 90 put is the most actively traded options contract Thursday, with more than 152,000 contracts traded. In addition, about 61 percent of the volume has traded ask-side of the bid-ask spread and ISEE sentiment data, which tracks the percentage of trades that are customer buy orders, indicate that brokerage customers bought-to-open 123,000 puts on the Spyders today.


Like the VIX, which is set to close near 27 for the first time since September 2008, implied volatility in SPY options is trending lower as well. (Since VIX tracks the expected volatility of S&P 500 index options and the SPY is designed to mimic the performance of the index, implied volatility of SPY options will mirror the VIX). Now, some investors are taking advantage of the recent decline in implied volatility (options premiums) to buy portfolio protection in the form of SPY puts.

Costco (COST) is up $1.21 to $46.25, as some of the retailers see gains Thursday following better-than-expected results from Bed, Bath and Beyond (BBBY) and Nike (NKE). In the options market, 23K COST puts traded on the day, which represents about 4X the expected. July 45 puts are being sold, with 20.4K traded and 86 percent hitting bid-side. Some players might be closing out trades opened one week ago when COST July 45 and Jan 40 puts saw increasing buying interest. Read more on recent activity in COST.

Bearish flow continues in French pharmaceutical maker Sanofi Aventis (SNY)–chart. As noted before the bell, traders were active in August 32.5 puts Wednesday. Today, the stock is down $1.59 to $30.25 and another 7,500 puts traded, compared to 250 calls. July 30 puts are the most actives and the top two trades (1000 ea.) hit bid-side for 90 and 95 cents on the PHLX, but were put purchases, according to a contact on the floor. 5,200 now traded. Looks like buyers of August 30 puts as well. Implied volatility is moving above 40, up from 36.5 yesterday. The bearish flow comes on the heels of a WSJ story that said SNY will dive into generic drugs and cut research spending.

Legg Mason (LM) hit a high of $26.74 today, but was recently moving back towards $25 after the Wall Street Journal reported that Nelson Peltz has not accumulated a position in the asset manager. The report comes the day after British paper The Telegraph said Peltz had secretly purchased 9 percent of the company and was seeking to oust some of the firm’s senior management (Link.) Heavy trading in the options market continues, with 14,000 calls and 5,450 puts traded. Implied volatility is little changed around 65.

Genworth (GNW) is up a penny to $6.58 and 3,550 July 7.5 calls traded. 92 percent hit at the offer and, while existing open interest is 9,900 contracts, ISEE sentiment numbers (47 percent or 1,100 contracts) indicate that some investors are buying-to-open–possibly looking for a move beyond $7.5 by the July expiration (22 days). Implied volatility is up to 94, from about 92 yesterday.

Livonia, MI-based Valassis Communication (VCI) is up 12 cents to $5.97 and options volume in the marketing services company is running 22X the average daily Thursday. While 260 Sept 10 calls traded, Sept 7.5s are the most actives, with 2700 changing hands and nealry all of the volume hitting ask-side. The top trade is 1000 for 65 cents on the CBOE. The trade was a firm buyer, according a contact on the exchange floor. Implied volatility is moving up to 93, from about 90 the day before.

Allscripts (MDRX) shares have gapped up $1.10 or 7% to a new 52-week high of $15.40. After yesterday’s close company raised full year guidance on higher expected sales. Options have traded 4x daily average. Feature is buying in the Sep. $15 calls in which 1,393 contracts have traded, 75% at the ask of $1.70, against prior OI of 2,953 in the strike. This is possibly closing of a position initiated on June 10 when 1,040 contracts were opened at $0.95 when stock was trading $13.80. The $17.50 line in Aug & Sep. calls have also seen increased activity with 65% of trades at the ask price indicating some fresh buying.

Takeover chatter infected Valeant Phramaceuticals (VRX) Thursday morning. The unsubstantiated talk sent shares up 78 cents to $25.38 and a new 52-week high. Options activity is picking uip as well. Total volume is already running 3X the usual, with 5,900 calls and only 54 puts traded so far (chart.) Premium sellers are responsible for some of the activity, as about three-quarters of today’s calls hit bid-side. However, the demand for premium and expectations of a possible move higher in VRX shares pushed implied volatility up to 46, from about 42 the day before.

Sentiment is shifting. After a three-month 40 percent rally in the S&P 500 (.SPX) from early March to mid-June, many indicators pointed to relatively high levels of complacency, optimism, and bullishness among investors. Since June 11, however, the S&P 500 is down roughly 4 percent and a number of indicators now suggest that levels of anxiety and bearishness are on the rise. The shift is noteworthy, as it comes amid relatively quiet trading in June and ahead of a seasonally weak period for the equity market during the month of July.

Investors Intelligence reports that bullishness declined and bearishness rose for a second consecutive week. Their historically reliable survey of investor attitudes now indicates that 43.6 percent of those surveyed are bullish, down from 44.8 percent last week and 47.7 percent two weeks ago. Bearishness rose to 28.7 percent, up from 26.4 percent the week before and 23.3 percent on June 10.

The ISE Sentiment Index [ISEE] also points to falling levels of bullishness. ISEE, which is updated throughout the day on the International Securities Exchange web site (iseoptions.com), tracks daily call buying divided by put purchases on the ISE, which is the largest exchange for trading equity options. When ISEE rises it indicates that call buying is high relative to put purchases (sales are ignored), which happens during periods of optimism and bullishness. Thursday, ISEE fell to only 90 and one of its lowest readings so far this year. Like the readings from the sentiment surveys, the decline in ISEE is a sign that some of the recent optimism is fading.


ISEE Sentiment Indicator (source: iseoptions.com)

Shifting sentiment is important. After the market crash of 2008, investor confidence had been lost. Pessimism had reached an extreme and, only once some confidence had been restored could the equity market begin to move higher. Beginning in March 2009, falling levels of negativity and increasing optimism turned into a self-feeding cycle that sent the S&P 500 up 40 percent over the course of three months. That trend continued in May. For example, AMG Data reports that mutual funds saw net inflows of $21.4 billion last month, confirming that money was still flowing into equities.

Trading has been quiet thus far during the month of June. The average daily move in the S&P 500 (excluding Wednesday’s 5.8 point gain) is 8.3 points, which is the least volatile month of the year. The average daily move in the S&P 500 during the first five months was almost 15 points (see table below). Yet, despite the quiet market action, it appears that risk perceptions and bearishness are beginning to rise. What happens to investor sentiment if volatility really picks up and stocks move lower? Does it turn into another self-feeding and bearish cycle?

The month of July has been a historically bearish and volatile month for the stock market in recent years. The S&P 500 has lost ground during the month of July during 7 of the past ten years. The average loss is 3 percent.

Traders should prepare for the possibility of higher volatility in July. Here’s an idea: look for specific opportunities and situations to make money on the downside. Yesterday, our scans picked up about a half dozen “smart money” trades that involved substantial bets against specific companies or exchange-traded funds. These “negative delta” strategies represent educated options strategies that will produce profits if July 2009 develops into another sour month for the US equity market. Take a look at some examples. Sign up for a free trial.