The Expiration Effect
By: Rick Ackerman, Market Wise Black Box
Black Box Forecasts: "Six hours ahead of its time"
The August option expiration appears to be muffling the action on Wall Street, setting up a potentially dull Friday. One can never rely on this effect 100%, but absent any earth-shaking news overnight or this morning, the inertia is apt to persist until the close. The reason is that near-the-money puts and calls often influence expiration-day price action.
To understand why, let's take the example of a stock that was trading placidly near $60 yesterday (Thursday). If it stayed near that price throughout the day, the August 60 puts and calls would tend to exert an increasing "magnetic" pull on it -- a pull that would wax even stronger as the expiration countdown moved into its final hours on Friday. Because the dying August puts and calls will by then have shed nearly all of their time premium, the buying and selling of them will be unconstrained by the usual concerns about premium decay and volatility swings.
Since time premium is non-existent for an option the day it expires, there is no guesswork in calculating its theoretical value. (Intraday or weekend risks remain, however, and that is why theoretically "worthless" options can trade for as much as 20 to 30 cents up 'til seconds before they expire.) With the August 60 puts and calls thus stripped for action, it would be possible on expiration day for even small players to arbitrage tens of thousands of shares against them, locking in riskless (though usually small) profits.
Some of the stock/option combinations that traders employ have colorful names, such as jelly roll, buy-write, conversion and reversal. All can be great money-makers on expiration day -- so long as traders believe, to take our example, that the stock will not stray far from $60. But let a disquieting piece of news cross the tape -- news with the ability to move the stock above $62.50, say, or below $57.50 -- and placid equilibrium quickly turns into raucous panic.
In the former case, when the stock moves above $62.50, the magnetic pull will shift from $60 to $65, and traders who were complacent about covering "worthless" August 65 calls they'd shorted earlier would be scrambling to get them back. When they leap to pay exorbitant prices for those calls, other traders in a position to sell to them would hedge their exposure by jumping on the stock. That's one way for a short-squeeze to develop; when it happens to the downside, in this case catalyzed by the August 55 puts, it would be called a long squeeze.
The point here is that expiring options can peg a stock to a specific price, but look out if the herd decides that stock is capable of leaping up or down to the next-closest strike price.
[Note: I'm going camping with my family this weekend, so Monday's edition will be a little later than usual getting to you on Sunday night. In any case, it should be posted well before the opening.]
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DECEMBER GOLD
(316.10): As noted here earlier, the futures need to close above 320.50 for two consecutive days to avert a nasty pullback to as low as 302.60 over the next 2-4 weeks.
Click here for December Gold Chart.
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+ GoldCorp Inc
GG (9.37):
Vol: 913,600
Still no change. We hold 400 shares for an average 7.58.
Upside potential over the next 1-3 days is to 10.53, a hidden pivot, but that would have no particular consequences for us, so stand pat.
GoldCorp website
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+ Durban Roodepoort Deep
DROOY (3.28):
We hold 600 shares for an average 4.29.
Durban has been swimming against the tide, stochastically speaking, but it's still difficult to predict which of two targets will be hit first: 4.14 or 2.64.
My guess is the latter if non-bullion shares strengthen into next week.
Durban website
***
(The '+' symbol means we have an open position, while $ means there is actionable advice.)
DJIA (8818.14): No change. The Dow tripped a buy signal when it blew past 8545 on Wednesday. Since the close was slightly above a hidden pivot at 8736, odds now favor a rally to the target associated with that pivot, 9119. If the Dow can exceed that number by more than 8 points intraday, or close above it even slightly, it would be signaling an extension of the rally to at least 9260. If you're skeptical about this rally and looking for a low-risk place to get short, that'd be it.
$ SEP S&P (930.50): The 917.20 minimum projection given here yesterday was an obvious error, although the more important target above it, 969.70, will stand. Our minimum projection is now to 958.50, but even a slight breach of that pivot would imply high prices still, to at least 969.70. Either objective can be shorted until the final hour using the E-mini, but I'd risk no more the 0.75 points on a stop. If you initiate the trade you'll be on your own thereafter.
$ + OEX (469.78): We hold a Sep 500 call (OEBIT) for 3.30. Our minimum target for the near-term is 485.42, and we were offering the call to close for 7.90. Today, let's have some fun with it by offering a September 510 call (OEBIB) short for 6.00. If successful, we will possess a riskless vertical spread whose profitability would range from $270 on the low side to $1,430 on the high.
SEP BONDS (110 2/32): Our minimum projection is to 116 25/32, a target that we should allow 'til November to achieve. Meanwhile, the most logical retracement target is a Fib level at 108 27/32. I won't endorse trying to bottom-fish there, however, since "Fibs" are generally too well observed in this vehicle -- and far too obvious in this instance.
QQQ (24.53): Our minimum projection is still to 24.89, but there's nothing to trade because of the potentially conflicting influence of the 24.69 peak made on July 30. Once above the higher number, the Cubes could oscillate around $25 for a while, since that's where they spent a few weeks in late June and early July. We'll consider shorting Sep 25 straddles if premium levels are ample.
SEP NASDAQ 100: (989.00): When they exceeded a pivot at 980.00 yesterday the futures became an odds-on shot to reach another, more-important one at 1002.00. That would provide no compelling opportunity for us, since we never touch this pup when it is near 1000.
***
$ + AOL (11.86): We hold twenty September 15 calls (AOLIC) for 0.10. Continue to offer twenty August 15 calls (AOLHC) short against them, since ten actually traded at that price on Thursday. If any of you are able to sell at that price, please let me know via e-mail.
CSCO (14.36): Cisco must surmount the July 17 peak at 15.06 to generate an uptrend worthy of our serious attention, but in the meantime we won't buck the trend by attempting to short near a 14.50 target we've been using.
INTC (18.61): A hidden pivot at 19.29 is still our minimum target, but we won't try to short there because of its close proximity to the 19.11 peak made on July 30. Instead, let's bid 0.50 for four Sep 20 calls (NQID), contingent on the stock trading 18.50 or higher.
$ C (35.84): Our target is a hidden pivot at 38.17, and we'll try to get short there in the following way: Buy four September 35 puts (CUG) if the stock touches 38.12, paying no more than the bid reflected for those puts when Citi first touches 38.04.
$ + MSFT (49.77): MSFT's peak yesterday fell less than a half-point shy of the 51.20 minimum target we've been using. We were planning on getting short up there, but the odds would be somewhat less favorable if the stock touches the target today after having come so close to it yesterday. Those of you who still hold an August 45 call should be offering a round lot of stock short against it, since it is a better way to catch the top than trying to sell the call itself. (Note: If you sell 100 shares of stock against a long August 45 call, it is the equivalent of buying an August 45 put.)
BBH (88.75): The cheapest way to play a move into the 90s will be to buy Oct-Sep 95 calendar spread, legging it on buy-side first. We'll wait until the August options expire before we attempt this.
[Note: I'm going camping with my family this weekend, so Monday's edition will be a little later than usual. In any case, it should be posted well before the opening.]
Rick Ackerman
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