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ETF Options Players Purchase Puts, Puts, and More Puts


This was a consistent theme as investors positioned themeslves in equity market's strength.

Editor's Note: Paul Weisbruch is the VP of ETF/Index Sales and Trading at Street One Financial, an ETF liquidity provider focused on quality trade execution as well as portfolio construction and product strategy in the ETF space.

Last week, all of the major equity indexes closed at their highest levels since January of this year, with the exception of the Dow Jones Industrials, tracked by the ETF, DIA (SPDR DJ Industrial Average) closing marginally off the mid-January high. The NASDAQ 100, tracked by the ETF QQQQ (PowerShares QQQQ Trust), the S&P 500, tracked by SPY (SPDR S&P 500) and IVV (iShares S&P 500), and the Russell 2000, tracked by IWM (iShares Russell 2000) marched higher all week, closing at new 2010 highs. From a sector standpoint, the winners were Telecommunications Services (up 2.21% for the week), Financials (up 2.10%), Technology (up 1.97%), and Industrials (up 1.57%).

How did ETF options investors position themselves last week during the strength in the equity markets? The answer is puts, puts, and more puts. In fact, last week was one of the busier weeks in recent recollection as far as options trades on broad-based products are concerned. In assorted State Street Select Sector Spyder products, downside put buying was a consistent theme, with sizable trades hitting the tape in XLP (SPDR Consumer Staples), XLF (SPDR Financials), XLY (SPDR Consumer Discretionary), and XLK (SPDR Technology). Additionally, in more broad-based instruments, we saw simultaneous buyers of protective downside puts in QQQQ, EFA (iShares MSCI EAFE) and in the SPX (S&P 500 Index) index itself. Large trades hit the tape in QQQQ, EFA, and SPX shortly before the closing bell on last Thursday.

It should be noted that of all of the put buying, the closest active month we saw was September, with most of the activity occurring in longer-term December and even January 2011 puts. VIX (CBOE Volatility Index) watchers have likely noticed that the index, despite a brief pop mid last week, is trading in the 17s, near its lowest level since $15.82 was briefly touched in May of 2008. The VIX is calculated from the prices of all at-the-money and out-of-the-money S&P 500 Index puts and calls in the two front months. As noted by Stephen Sears in last week's "The Striking Price" in Barron's, many investor incorrectly equate relatively low VIX levels with investor complacency. But as you can see, watching the VIX is a worthwhile tool, but not terribly helpful as a directional gauge if notable options activity in the market is occurring in contracts that are further out than the front two months. Options players also watch the Put/Call ratios, and last week's activity was a mixed bag as compared to the previous week. For the S&P 100 options, the put call ratio was 95/100 as opposed to 86/100 the previous week, and the CBOE Equity Put/Call ratio was 50/100, down from 59/100 the previous week, indicating more call activity than puts across equities. Historically, S&P 100 put/call ratios above 100/100 are considered bullish, and likewise for the CBOE Equity put/call ratio, on readings above 60/100 (Source: Barron's.)

Watching ETF options activity can be helpful to investors because it's extremely hard to discern buying versus selling activity in the ETFs themselves, nor is it terribly meaningful since many large institutions and investment firms exclusively use ETFs for hedging and could buying or selling against long equity positions. So the trading volume day to day in ETFs can be considered as "noise" to many. That said, there's a clear sentiment amongst the ETF options players that were present in the market last week, and the tone of the trading had a protective to bearish slant. It's very possible that investors who have been long for the past few months or quarters and have participated in the market's upside purchased puts last week to lock in their gains to some extent, and protect from any possible reversal that could occur later this year. This is probably the more likely scenario as opposed to the put buyers being outright bearish speculators loading up in anticipation of a correction

Longer term, market technicals remain "positive and intact," according to Street One Financial's market technician David Chojnacki but with the NASDAQ 100 up over 10% from its February correction low, it runs the risk of being "slightly overbought in the short term, with 1920 being a longer term congestion area."

What's next for the market? Technicals remain sound, and the equity indexes have been marching higher as opposed to bolting higher, although volumes haven't been convincingly heavy (trading anywhere from 50-75% of the levels we saw during the February correction), so I'll continue to monitor ETF options activity to discern where on the table larger institutional players are placing their chips.
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