Morning Note

August 25, 2011




US equity futures are trading below fair value, though have improved in the past couple of hours. The relative underperformance in Nasdaq futures is due to the resignation of Steve Jobs as CEO of Apple (AAPL). Investors are waiting on the weekly jobless claims data which comes out at 08:30 ET.



Libor fixings 


- Overnight Libor: Dollar: 0.144% vs prior 0.144% ; Sterling: 0.580% vs prior 0.580%; Euro: 0.841% vs prior 0.840%
- 1-month Libor: Dollar: 0.221% vs prior 0.219% ; Sterling: 0.655% vs prior 0.655%; Euro: 1.294% vs prior 1.295%
- 3-month Libor: Dollar: 0.319% vs prior 0.314% ; Sterling: 0.880% vs prior 0.880%; Euro: 1.480% vs prior 1.480%


WTI +$0.57 at $85.73


Natural gas +0.003 at $3.922


Spot Gold ($44.00) at $1705.00




Asian Markets


Asian markets followed Wall Street up today, but tech stocks were hurt by Apple (AAPL) CEO Steve Jobs’s resignation. Property and financial companies led China to a gain. Japan followed Wall Street up with a boost from a weaker yen. Australia rose strongly but then gave up some gains. BHP Billiton and Ramsay Health Care rose 1% and 4%, respectively, on results. The yen is trading at 77.05 to the US dollar.


European Markets


European equity markets opened higher extending gains to a fourth session before becoming range bound as corporate results from the likes of Credit Agricole, Glencore International and Diageo buoyed sentiment. Focus remains on the meeting of central bankers in Jackson Hole with Fed Chairman Bernanke scheduled to speak tomorrow. After the close yesterday, France announced its 2012 budget, cutting GDP forecasts for 2011 and 2012 to 1.75% and 1.75% from 2.0% and 2.25% respectively and announcing additional measures to bring its deficit reduction goals back on track. Germany Sep GfK consumer sentiment 5.2 vs consensus 5.2, prior revised 5.3 from 5.4. UK Jul consumer confidence 49 vs prior 51. The pound and the euro are trading at $1.6361 and $1.4418 respectively.




Today's Economic Releases (Eastern Time)


08:30 US Initial Jobless Claims (20-Aug); consensus 404K
08:30 US Continuing Claims (13-Aug); consensus 3700K
09:45 US Bloomberg Consumer Comfort (21-Aug); consensus n/a
10:30 US EIA Natural Gas Inventories (19-Aug); consensus n/a
19:30 Japan CPI (y/y) (Jul); consensus n/a
19:30 Japan Core CPI (y/y) (Jul); consensus n/a 


Today's Key Events (Eastern Time)


08:00 GT Advanced Technologies acquires Confluence Solar: 800.901.5247pc GTAT
13:00 Treasury Auction of 7-yr notes
14:00 AMERCO Virtual Analyst and Investor Meeting
—:— FDA PDUFA: Class 2 resubmission of NDA for Shire’s Firazyr for acute HAE
—:— Marcellus NGL & Shale Gas Infrastructure Summit
—:— RedChip Small-Cap Equities Virtual Conference 




Company Specific


Earnings
BIG (Big Lots Q2 EPS $0.52 ex-items vs Reuters $0.44)
FRED (Fred's reports Q2 EPS $0.13 vs Reuters $0.13. Reports Q2: Revenues $452.7M)
GES (Guess? reports Q2 EPS $0.84 vs Reuters $0.81; Guides FY EPS to $3.25-3.35 vs prior guidance $3.30-3.50 and Reuters $3.43)
HRL (Hormel Foods reports Q3 EPS $0.36 vs Reuters $0.35; guides f11 EPS $1.70-1.75 vs prior guidance $1.67-1.73 and Reuters $1.72)
PSS (Collective Brands reports Q2 EPS $0.16 ex-items vs Reuters $0.11, to review strategic alternatives ($10.74))
RGS (Regis Q4 EPS $0.37 ex-items vs Reuters $0.30)
SAFM (Sanderson Farms reports Q3 EPS ($1.86) ex-items; revenues $511.2M vs Reuters $512.9M)
SMTC (Semtech (SMTC) reports Q2 EPS $0.49 ex-items vs Reuters $0.48)


Other News


US may back refinance plan for mortgages: The NY Times reported that the Obama administration is considering a proposal that would allow millions of homeowners with government-backed mortgages to reduce them at today's low interest rates (~4%). The article noted that a refinancing wave could provide a strong stimulus to the economy (one estimate said it could save homeowners ~$85B a year), but could also face opposition from the regulator who oversees the GSEs and from MBS investors. The refinancing idea, which has been around since at least 2008, was highlighted yesterday in a report by National Mortgage News.


Bank-owned US home sales stay high in Q2: Reuters, citing a report from RealtyTrac, said that the number of bank-owned home sales remained high in Q2, while sales of homes in default or scheduled for auction rose sequentially. The article noted that overall sales of homes in some stage of foreclosure or owned by banks totaled 265.087, up 6.5% from a revised 248.959 in Q1. Rick Sharga, senior vice president at RealtyTrac, said that "In the face of an overall market where we're seeing home sales declining, the fact that we're seeing an increased number of distressed properties being sold suggests the market is correcting the way it needs to".


New York spars in foreclosure talks: The WSJ reported that a push to forge a consensus among government officials seeking to negotiate a broad foreclosure settlement with banks is stumbling in the face of efforts by New York State Attorney General Eric Schneiderman's to include both consumer and investor claims. The paper added that one state official involved in the foreclosure negotiations said that adding investor claims could delay a settlement by as much as two years. The article went on to note that while consumer groups and bond investors have both expressed dismay with servicing practices, their interests are likely to diverge when it comes to hashing out a settlement and allocating funds collected as part of any deal.


Bernanke likely to forgo easing as data point higher: Bloomberg reported that Fed Chairman Bernanke may disappointment investors betting on a commitment to step up stimulus. The article noted that further policy accommodation is constrained by rising consumer prices and a US economy that it is still growing. Bernanke unlikely to promise new action by the Fed: The WSJ's David Wessel said that despite markets' lingering hopes, Fed Chairman Bernanke is unlikely to use his speech on Friday in Jackson Hole to unveil new measures to bolster the US economy. The article noted that neither Bernanke nor officials close to him have said anything to encourage speculation that he will give in to market pressure to say say anything that suggests imminent Fed action.




Newspaper Articles / Headlines


Financial Times
- South Korea seeks consortium to build mobile phone operating system. The FT reports that the government announced yesterday that details of its plan would be revealed in October. It has invited Samsung Electronics (005930.KS) and LG Electronics (066570.KS) to join it, though smaller companies will have about 50% of the consortium, which the country is looking to build partially because it fears over-reliance on Google (GOOG).
- French regulator tells Electricite de France to fix "gaps and weaknesses" in its €6B next-gen nuclear plant at Flamanville. The FT reports that a letter was sent in June, but only became public yesterday, and EdF said the concerns would all be addressed by 31-August.
- Eni CEO Paolo Scaroni, Italian PM Silvio Berlusconi to meet Mahumd Jibril in Milan today. Jibril is the leader of Libya’s national transitional council; Scaroni tells the FT that the three will discuss "the council’s need for fuel supplies." Carillion CEO John McDonough to resign at end of year. He will be replaced by COO Richard Howson.
The announcement was made with yesterday's earnings.
- Charter may extend Melrose's (MRO.LN) put-up-or-shut-up deadline. A source close to the situation tells the FT that Charter gave its undisclosed bidder some private information, and that information is expected to also be provided to Melrose.


Wall Street Journal
- WSJ discusses how Apple's board handled Jobs' succession plan. The article notes the board has been criticized for the lack of transparency with respect to Jobs' health and who would ultimately succeed him. AAPL spokeswoman Katie Cotton said that a succession plan had been in place for several years, though had been kept confidential for competitive reasons. The article says that succession may still be an overhang for the company, with Stephen Davis, executive director of the Millstein Center for Corporate Governance and Performance at Yale School of Management, saying that AAPL should clarify Jobs' role as chairman and his health situation
- WSJ is positive on Bank of America -- that is, Bank of America's senior debt. A "Heard on the Street" column notes that BAC bonds carry high yields and come with greater protections than equity holders get.
- 9/11 victims' relatives meet AG Eric Holder, seek closure on allegations of phone hacking by News of the World. The WSJ reports that the families are far more interested in justice than speed, and they'd like the government to be sure that there was no hacking of information from realms beyond phones.
- WSJ is cautious-to-negative on Apple. A "Heard on the Street" column says that the company is in solid shape for the short term, but the stock may decline anyway until it is clear that CEO Tim Cook can keep talent on board. The column also notes that Steve Jobs was better-placed than Cook is to give the company a chance at expanding in Hollywood.
- WSJ is cautious on BHP Billiton. A "Heard on the Street" column says that despite glorious FY results, the company faces rising costs and the potential for lower commodity prices. BHP also arguably spent too much on both its stock buyback and its purchase of Petrohawk Energy (HK), so even if it is the best miner available, for the moment, that's kind of like being the world's tallest pygmy.
- WSJ says Japanese conglomerates should get out of PCs. A "Heard on the Street" column says Toshiba (6502.JP), NEC (6701.JP) and Fujitsu (6702.JP) are starting behind and fading fast in terms of their unprofitable, unpopular computers.
- WSJ is positive on European oil majors. A "Heard on the Street" column gives greatest props to Royal Dutch Shell (RDSA.LN), and also says that Eni (ENI.IM) and Total (FP.FP) are cheap.


Washington Post
- State Department's environmental assessment of Keystone XL pipeline to affirm project will have “limited adverse environmental impacts”. The Washington Post cites sources familiar with the assessment, which could be released 26-Aug. The project also needs to be deemed to be in the national interest before the department can make a final decision.


Women's Wear Daily
- Deckers Outdoor settles suit against Emu; terms undisclosed. Women's Wear Daily reports that Deckers sued in Los Angeles federal court in December to protect its Ugg trademark inAustralia, where Emu claimed that "ugg" is a generic word. Claims were dismissed, and both parties are paying their own costs.




Research


Auriga: downgraded UTHR
Bank of America: upgraded CASY
Benchmark: downgraded ECA
Cowen & Co: upgraded CCSC
Deutsche Bank: upgraded GAME
Janney Capital: upgraded TTC
Keefe Bruyette: upgraded PEI
RW Baird: upgraded SNCR
Societe Generale: upgraded BHP
Stifel Nicolaus: upgraded FFIV, QLTY, RA




Options


Ominous Signs from Vol and Credit Markets


On a day when the market rallied 1.31%, we find the more modest 1.02% decline in the VIX to be an ominous indicator of market sentiment. The credit markets provided additional “bear- fodder” with the US Investment grade CDS index ticking lower by a modest 45bps and major European bank CDS levels rising for a 7th session. With Ben Bernanke’s speech this Friday in Jackson Hole, the release of FOMC minutes on Tues and an FOMC meeting on 9/20, market volatility looks unlikely to abate any time soon.


Gold stole the spotlight as futures fell 5.6%, the largest since Mar 2008. A sharp intra-day drop was interpreted by many as a rush to the exits ahead of this Friday’s Jackson Hole address which is increasingly viewed as an unlikely forum for the Fed to make additional stimulative promises. The move was exacerbated by a late afternoon announcement that the CME will raise margin requirements on gold futures by 27% effectively reducing the leverage available to speculators who trade the commodity


How Two Days Can Equal a Lifetime When it Comes to Gold. Today’s move adds to the acceleration in gold volatility we had begun to witness before today and is evident in successively higher levels of realized volatility at the 30, 20 and 10 day horizon. At 39.9, 10-day realized volatility in gold is at its highest level since March of 2009. Interestingly, the ~11 point vol premium being assigned to Aug weekly options (expiring 8/26) over Sep options (expiring 9/17)  gives us a good glimpse into the markets expectations for continued fireworks into this Friday’s Fed speech. To put it in perspective, Aug weekly 172 calls with 2 days left until expiration have roughly 36% of the value of the same options expiring in Sep (24 days to maturity). While the short-dated vol premium may seem extreme on the surface, we caution against jumping to any quick conclusions.


While we admittedly have no edge in predicting the direction of gold over the next two days, we are more confident in the fact that it is unlikely to stay where it is today. In fact, based on the two-day, -7.22% move in gold it is not altogether unreasonable to conclude that in two days, the current $1750 price of gold futures may be nothing more than a distant memory (one way or another).


Following this line of reasoning, we remind readers of one of the fundamental characteristic of options- The farther in the money an option becomes, the more it behaves like the underlying security itself and the less it behaves like an option (i.e. delta goes toward 1, gamma, vega and theta go toward 0). At the extreme, options which are close to 100% in the money trade almost exactly at their “intrinsic value” (difference between spot and strike) with little to no time-value (optionality) assigned to options of longer maturities.


Following this logic, a big move in gold over the next two days likely means that the value of in-the-money options will converge even if one option expires in a matter of hours and the other in a matter of weeks. It is by this logic that investors who believe gold will make a big move over the next 2 days may want to look at buying the Aug weekly 172 straddle to sell the Sep 172 straddle for a net credit of $6.49 (3.98% of spot). This trade is otherwise known as a “straddle swap”  


To illustrate how the trade might make (or lose) money, (1000 contracts per leg) at c.o.b. this Friday given a range of prices outcomes in GLD and the assumption that volatility comes in by 2 points. By our calculations, the trade breaks even with GLD above 175.55 (+2.27%) or below 168.70 (-1.72%) at Friday’s expiration- less than any one of the moves made by GLD over the past 3 days.


Notice as GLD moves farther away from current spot (~$171.65), not only does the  p&l moves closer toward the total premium received upfront (+$649,000), but delta, gamma, vega and theta all move closer to zero. This is a direct result of the long (Aug weekly) and short (Sep) in-the-money options converging with respect to value and risk sensitivities.




GLOBAL NEWS

n  GOLD�

1.      Gold fell for a third day, extending its biggest drop since February 2010.  CME raised margin requirements after gold futures surged to a record above $1,910 an ounce this week.

2.      Stocks and gold futures are moving in opposite directions by the most since September 2008.

n  GREECE�

1.      Finland�s demands for collateral on loans to Greece may trigger a default on $26B.

2.      Greek spreads vs Bunds hit record highs on bailout concerns

n  HURRICANE IRENE� the strongest Atlantic storm to threaten the U.S. since 2005, struck the Bahamas on a course that may take it near North Carolina this weekend and New England next week.

n  EU� EU stock-market regulators will decide as soon as today on whether to extend temporary bans on short selling that they introduced this month.

n  ECB� ECB �stands ready� to ease tensions in U.S. dollar funding of European banks if they arise

n  MEXICO� Yields on Mexico�s dollar- denominated century bonds are soaring to a record relative to securities due in 30 years on concern the FED�s efforts to shore up the U.S. economy will spark inflation.

n  U.K.� U.K. Consumer Confidence Declines as Outlook for Economy Weakens

n  POTASH-- Farmers boosting crop output have helped bolster the price of potash by 47 percent in the past year.

n  SWITZERLAND� Switzerland  and the U.K. reached an agreement to end a dispute over tax evasion by wealthy Britons holding offshore accounts with Swiss private banks. Swiss banks will pay $629MM.

n  DENMARK� Danish Housing Rescue Faces Bank Opposition as Market Freezes

n  SYRIA-- Syrian security forces have killed at least 25 protesters in the past two days as activists and opposition groups prepare for a conference.

n  CHILE-- Chileans are bracing for a second day of nationwide work stoppages and street protests.

n  LIBYA� Qaddafi�s Ouster Leaves Messy Clean-Up for Libya and Big Oil

n  AUSTRALIA-- Australia Poised to Become First to Ban Tobacco Package Logos






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*Special thanks to Option Radar, BMO Capital, MEB Options, Bloomberg, Reuters, Optionistics, LiveVolPro, CBOE, AMEX, Option Monster, T.O.P. group, and all of the options desks and traders we work with to provide the option flow!


 No position at this time. Position declarations are believed to be accurate at time of writing but may change at any time and without notice.