Options Trading Shows Cautiously Bullish Sentiment on the Rise

The bulls are running in the wake of the surprise interest-rate cut, but is this a marathon or just a short-distance sprint? It's not entirely certain, but if options trading is any indication, things are looking cautiously optimistic for a longer-term rally.

Volatility Index
Today	% Change
28.16	-1.1%
Source: ILX

While volume is lighter today after Wednesday's record-setting session on the Chicago Board Options Exchange, options traders are continuing to make bullish bets by buying call options.

Nasdaq Volatility Index
Today	% Change
68.74	-1.4%
Source: ILX

On Wednesday, 2,695,462 contracts were traded, the most in CBOE history. This total volume figure represents an estimated total premium value of $2.5 billion traded on the CBOE. After the Federal Reserve announced that it was cutting interest rates by half a point, investors scrambled to get their call-option buy orders on the books as the market soared on the news.

According to Andy Schwarz of AIG Specialists, "the options market is still way above average with respect to customer interest." Schwarz says that because there is so much money tucked away on the sidelines by jittery investors, when a buying opportunity presents itself, the masses are jumping right in.

Call option volume continues to be heavy in the Nasdaq 100 Unit Trust(QQQ Quote), with the April 40 calls being gobbled up on the buy side at a premium of $7.70. Shares of the QQQ traded up 2.9% to $46.85 in recent trading.

Volume in options trading on Microsoft(MSFT Quote), which posts earnings later today, was hefty, with the April 65 puts being the most heavily traded. More than 25,000 put contracts were registered, compared to open interest of 20,719. On the flip side, there is also a lot of call-buying in the May 65 and May 70 options. Shares of Mister Softee traded up 3.7% to $67.89 in recent Nasdaq trading.

Schwarz says a lot of investors are using options to hedge their bets on the upside, adding that this kind of "creative trading" is not limited to the institutions. Many small-time investors and daytraders are using options to cautiously express their bullish sentiment on a stock. In a time when we are still unsure if this most recent spike in the market is a bear market rally or a return to a bull market, options are a useful tool to express such bullish sentiment without laying out the capital, Schwarz says. Worst-case scenario: If the stock tanks, the option expires worthless and it only cost you the price of the premium. Tech stocks, in particular, are the beneficiaries of this wary optimism.

As for volatility in the options market, the VIX -- a measuring stick for fear among investors -- fell 1.1% to 28.16 in early afternoon trading, meaning volatility was easing. Implied volatility typically rises when the demand for options increases. The Nasdaq Volatility Index dropped 1.4% to 68.74. Volatility, along with time and intrinsic value, are the key components of establishing the premium on an option.

Elsewhere on the options front, after an upside surprise from copier king Xerox(XRX Quote), many investors flocked to the options exchanges to do some bullish call-buying. Xerox posted a first-quarter operating loss of 12 cents a share. Analysts had been expecting a loss of 28 cents a share, according to Thomson Financial/First Call. The company, which has been plagued by liquidity problems, reported revenue of $4.16 billion, down 8% from $4.5 billion a year earlier.

Call option volume was heavy in the May 7 1/2 calls with over 6,200 contracts traded as compared to an open interest of 3,283. The April 7 1/2 calls were also actively traded, with 4,500 contracts traded compared with an open interest of 9,488.