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  • Trading was very light today.  Volume was light, but breadth was quite negative.  Almost 80% of all issues on the NYSE declined today.
  • The VIX jumped over 5% today.  Investors who were seen reaching for protection yesterday were reward today.

VIX – CBOE Vix index – With the equity market down and the dollar on the rise, investors across different asset classes today appear to be blaming one another for prevailing direction. No one seems to know why anything is moving in the fashion it is. The suggestion of course is that risk appetite is on the demise and fear is picking up. Compounding such indecision in the volatility class are trades suggesting ongoing disparate views on the fortunes for equities going forward. The so-called fear gauge is 5% higher at 24.90 today while trading has been two way. In the November options one investor loaded up on 25,000 call options at a 25 cent premium suggesting that the index will be above 25 when options expire next Tuesday. The December contract equally hinted at more volatility ahead as one traded bought the 27.5/35 call spread 25,000 times at a net 93 cents. In order for this trade to break even next month the Vix index would need to settle above 28.43. Arguing the bullish case another investor bought 15,000 put options at the December 20 strike, which suggests that volatility will subside into year end rally for equities.

  • Options traders were seen making some bullish moves in the dollar ETF:

UUP – PowerShares DB US Dollar Bullish Fund – A pair of bullish risk reversals on the PowerShares US Dollar Bullish Fund suggests today’s sharp rally for the dollar will likely continue over the next several months. We observed massive bullish plays on the UUP over the past couple of weeks, some tied to machinations of whether or not the fund had enough shares in circulation. But today’s activity predicts far more extreme movements in the price of the dollar index. The UUP is current up 1.4% to $22.80, while the dollar index, which it supposedly tracks, is up just 0.7%. Investors sold 4,700 deep in-the-money put options at the December 29 strike for an average premium of 6.30 apiece, spread against the purchase of 4,700 calls at the same strike for one nickel each. The high-delta put options hold very little extrinsic value because expiration is just over one month away. Thus, investors are expecting the intrinsic value of the puts to decline. The only way this will occur is if the dollar rallies forcing the UUP to increase. If traders’ bullish predictions are correct, the value of the long calls will appreciate, while premium on the short puts erodes. Such a scenario allows investors to profit by buying back the puts for less than the 6.25 net premium received on the reversal. A similar uber-bullish strategy was employed at the January 2010 28 strike price where investors sold 4,250 deep-in-the-money puts short for about 5.30 each, and purchased the same number of calls for 5 cents apiece.

Following yesterday’s modest rally in European credit, US opened tighter and rallied to the week’s tightest levels on jobless headlines and the ‘Job Summit’. Equities failed again at 1100 and helped by FHA comments, weak MBA apps data, and an outstanding effort on the deficit, slid gently lower. Credit wavered all but unch from Tuesday’s close for much of the day (covering yesterday’s small gains overseas) until a late day test of Tuesday’s lows in stocks and 100bps in IG13. HY broke $93.75 and underperformed IG but the sell-off was orderly and volume only picked up as we edged lower.

Indices swung from out- to under-performing intrinsics on the day with low beta names notably underperforming higher beta. Europe closed basically unch from Tuesday’s close while US closed wider although while stocks were able to break Tuesday’s lows, IG and HY were not (although DXY and VIX are notably higher).