Today’s tickers: AA, RIO, TGT, HD, IP, VIX, ORCL, COGO & FRED

AA – Alcoa Inc. – The producer of aluminum has dropped more than 9% to $5.55 after the company slashed its dividend by 3 cents in an effort to cut back on capital spending. AA hopes these measures will help strengthen its position in the case of a lengthy economic downturn. Most of the action in options-land occurred on the put side as investors seek to profit from declines in the share price. Fresh buying was observed at the March 5.0 strike price where around 25,000 puts were picked up for an average of 15 cents apiece out of the 47,000 puts traded at the strike. Shares of Alcoa would need to fall another 12% by Friday in order to reach the breakeven price of $4.85 – the price at which put-buyers begin to amass profits. Similar purchases were observed at the 5.0 strike in April where some 53,000 puts changed hands throughout the day at an average premium of 52 cents per contract. Interestingly, one investor was seen looking for recovery in the October contract by purchasing 4,000 calls at the 7.5 strike for 1.10 each. We believe this transaction was funded by the sale of 8,000 calls at the April 7.5 strike price for a premium of 23 cents each. This investor does not see Alcoa rebounding in the next 30 days, but he is optimistic that shares will increase by about 35% in order for the calls to land in-the-money by expiration in October. In stark contrast to the optimism seen in the previous trade, one investor picked up 12,000 puts at the 2.5 strike price in January 2010 at a cost of 50 cents per contract. This trade predicts nothing but doom-and-gloom for Alcoa all the way through to the start of next year.

RIO – Companhia Vale do Rio Doce ADS – Shares of the metals and mining company have rallied 2% to $13.73 perhaps due to the selection of a new chairmen-designate who stated that his immediate focus would be centered on finalizing the transaction with Chinalco (Aluminum Corp. of China). Global economic conditions continue to thrash commodity markets and Rio Tinto sees little chance of a rebound this year. Thus, the new chairman (Jan du Plessis) is hoping that finalized deal – which would increase Chinalco’s stake in RIO to 18% – will provide RIO with a sturdier platform with which to ride out the current economic storm. Option traders were active in multiple contracts today and appeared to be selling volatility which has come off from 80% at the beginning of the trading day to the current reading at 73%. In the April contract one investor established a sold strangle by selling 8,000 puts at the 12 strike price for 59 cents, and by selling 8,000 calls at the April 15 strike for 57 cents apiece. The gross premium pocketed amounts to 1.16 and will be retained by this trader as long as shares remain within the boundaries of two strike prices described. A similar sold strangle was initiated in the June contract where 3,000 puts were shed for a premium of 95 cents at the June 11 strike price, and 3,000 calls sold for 1.37 each at the June 15 strike. The gross premium enjoyed amounts to 2.32 and creates breakeven points at $8.68 on the downside and $17.32 on the upside. If shares swing outside of either of the breakeven points by expiration, the entire 2.32 premium will have eroded leaving the trader vulnerable to losses.

TGT – Target Corp. – The retailer has experienced a 5% rally in shares to $30.25 and popped onto our ‘most active by options volume’ market scanner after a couple of large volume trades were established in the April contract. Optimistic traders were also active in the March contract where 5,000 calls were purchased at the 32.5 strike price for 12 cents apiece. Delta on the trade yields a slim 10% chance that the calls will land in-the-money by this Friday as shares would need to rally an additional 8% from the current price in order to breach the breakeven point at $32.62. The April contract was the bulls-eye for one investor who appears to have purchased 32,000 calls at the April 30 strike price for 2.06 each. The same trader picked up an additional 62,000 calls at the 32.5 strike for 97 cents apiece. Finally, uber-bullish traders bought 4,000 calls at the April 45 strike price for 4 cents each. Shares would need to bulk up by 48% in order for these calls to land in-the-money by expiration next month, although the investor is likely just looking for any continued momentum to boost premiums incrementally.

HD – Home Depot, Inc. – Shares of the home improvement retailer have rallied 5% to $21.15 as a rise in February housing starts offers positive news for investors. Home Depot had its target share price lifted to $24 from $20 alongside an upgrade to ‘buy’ from ‘hold’ at Jefferies. Option traders hit the ground running after the 22% surge in U.S. housing starts in February provided a much needed dose of optimism. Traders were seen getting bullish in April, buying 5,000 calls at the 25 strike for 10 cents each. Meanwhile, in the May contract investors picked up 4,400 calls at the 25 strike for 35 cents apiece. Further along at the August 20 strike price, 4,500 puts were sold for 2.31 each and spread against the purchase of 4,500 calls at the August 30 strike for 28 cents per contract. This optimistic investor pockets a 2.03 credit and is likely hoping for further upside improvement on the stock. The calls would begin to yield profits if shares were to rally by 43% to the breakeven point at $30.28 by expiration in August.

IP – International Paper Co. – Management yesterday took a chainsaw to an outstanding debt covenant reducing its obligations and turning sentiment on the stock positive. It would appear that an earlier decision to reduce its dividend payout, which created negative share price action at the time, was a wise one from the Tennessee-based paper-company. While the move sparked a jump in implied options volatility as the stock reached record lows, the benefits are quickly being displayed. The company recently announced the re-jig of a loan agreement in which the company used some of its cash to pay down the overall burden and in so doing has allayed liquidity fears. Shares added 13% to stand at $7.16 today and so well above the recent $3.93 low. Options traders meanwhile looked for further gains in coming weeks perhaps in expectation that the revamped financial structure might be more appealing to investors. Call options expiring in April and July offering buying rights on the shares at a fixed price of $7.50 were heavily trafficked today with volume at both strikes exceeding established bullish positions. Investors bought 14,800 calls expiring in April for 75 cents and more than 10,000 calls for 1.40 expiring in July. At 103% implied volatility seems rather high given management’s balance sheet tune-up.

VIX – CBOE Volatility index – One investor placed a large long butterfly combination in the May options in a trade that banks on implied volatility standing still, at least by the time expiration arrives. The VIX index is a little lower today at a reading of 42.86, while investors reservedly test the warmer waters surrounding the recent improvement in sentiment towards financial stocks in particular. The combination involved the purchase of 20,000 calls at each of the May 35 and 55 strike prices, while the investor sold twice as many calls at the central 45 strike for a net cost of around 2.40 per contract. This investor is largely at odds with the school of thought that takes the Bernanke line and also those who see a turnaround in financials as the first sign of a spring thaw for stocks. Those investors would by definition expect lower volatility to accompany higher share prices, while the butterfly trader expects a volatility hangover through early summer. The position would make the most if the VIX settled at a reading of 45 at May’s expiration in which case the investor would make maximum gains of 7.60 per contract.

ORCL – Oracle Corporation – Shares of the software company are off by about 1% to stand at $14.75. ORCL’s target share price and estimates for the 2010 fiscal year were revised lower by Jeffries in a report today. Oracle’s target price was cut from $20 to $18 and its earnings per share for 2010 were revised to $1.46 from $1.55. Despite the revision, today’s report did cite the ORCL’s ability to “cut costs aggressively” and hinted at potential M&A opportunities for the firm in the second half of 2009. One option trader took advantage of current pessimism by getting bullish in the January 2010 contract. Hoping for a turnaround into next year, this investor purchased 8,300 calls at the January 20 strike price for 70 cents apiece. The pure call buying suggests that he is looking for unlimited upside, though shares will need to rally by 40% from the current price in order to reach the breakeven point at $20.70 by expiration. The calls are only half of the story as the same individual also initiated a put spread set to expire in January 2010. At the January 15 strike price 8,250 puts were bought for 2.55 each, while at the 12.5 strike 8,250 puts were sold for 1.35 per contract. The net cost of the spread amounts to 1.20 and yields a maximum possible profit – should shares decline below $15 by next year – of 1.30 pocketed if the share price settles at $12.50. The establishment of the put spread alongside the bullish call buying suggests that this trader is willing to accept the negative news surrounding Oracle, although it seems that he would much prefer the software company to blow through analyst expectations by next year.

COGO – Cogo Group, Inc. – The provider of module design solutions has experienced a 2.5% decline in shares to $6.50 after disappointing earnings were released yesterday. COGO reported its highest annual revenue in history at $287 million for 2008, but its fourth quarter EPS of just 2 cents missed the 18 cent estimate for the quarter by a wide margin. The company edged onto our ‘hot by options volume’ market scanner after one investor sold 12,500 calls at the April 7.5 strike price for a 15 cent premium. While the calls traded to the middle of the market we believe they are likely to have been sold. The bearish sentiment evident from this investor’s sale is likely shared by other traders who must be wondering why the soaring revenues reported have not fattened COGO’s bottom line.

Freds, Inc. – One option trader took a pop at this discount general store by selling upside calls expiring in August. The company appears similar to Family Dollar in that it serves low, middle and fixed income customers and stocks 12,000 frequently purchased items. Family Dollar is one of a handful of companies that have performed well as the economic slump has deepened. Shares in Freds are almost 5% higher at $10.88 and we think what we’re seeing is evidence of a covered call strategy that would deliver about 50% gains on the stock alone should the share price advance to the 15.0 strike calls, which were sold today for around 45 cents. The strategy is mildly bullish and given the fact that Freds options are rarely visited, this trade sticks out like the proverbial sore thumb. Regardless of whether or not the share price does advance, the option seller retains the premium and the caveat here is that at expiration the investor must deliver shares, if the call buyer exercises his right to acquire stock.

Andrew Wilkinson

Senior Market Analyst

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