A Variety Pack – SPX, AAPL, CHF

Good evening, Friends. Today was interesting, and tomorrow, which features earnings from AAPL after the close, promises to be even more intriguing. The SPX remains, it appears to me, in an uptrend, but it’s clearly struggling. Good news from AAPL tomorrow would of course help, but for the moment, all we know is that the low that was put in on April 10 at 1357.38 has just barely managed to hold. Today it dropped as far as 1358.79, closing at 1366.94. That isn’t much breathing room.

Supposedly, the market was down today because China’s HSBC Flash PMI, a measure of manufacturing strength, came in below the 50 level (it was 49.1) that marks expansion. It was, however, an improvement over March’s 48.3. If the tone of the market was bullish, this would have been good news; the negative reaction tells us that we’re at least leaning with a bearish tilt. In addition, the Socialist candidate came in first in the initial round of the French presidential election. That was a bit of a surprise, but the current President, Sarkozy, has been widely expected to lose in the second (and decisive) round on May 6. Again, more a sign of the market’s tone than a call to action.

So, given the perilous state of the SPX, AAPL’s earnings release tomorrow will probably be significant. I have no idea what the earnings will be; I do know that AAPL has been in an uptrend since the end of December, and from there was able to move up by 57.4%, to a 644 high on April 10. It has since fallen on hard times, and fallen hard, down as much as 13.6% to a low of 556.62 before bouncing to 571.70. There has, of course, been plenty of selling, but there have been dip buyers on the way down who now hope to be redeemed by good earnings. It appears to me that the area around 565 remains as support, but of course on a poor report that level will be blown through, while a well-received announcement should create some separation from the low.

There are some interesting things going on in AAPL options ahead of the release. The weekly options that expire this Friday are trading at implied vols of 87.75 for the 570 calls, while the 570 puts show an IV of 87.50.  The implied vol levels for the regular May expiry are 48.1 for the calls, 47.29 for the puts, so someone buying a lottery ticket – or a straddle – today by purchasing the call and put with weekly expiry would need a move of 7.2% prior to expiry on Friday in order to break even, since the combined price on the offer is 41.25. I personally wouldn’t be inclined to pay up 40 or so vols in order to save some money in Dollar terms on the premium. Given the additional time value they offer, the options expiring in May have a higher premium (the 570 straddle is running roughly $55.00), but as the implied vols indicate, they are actually significantly cheaper.

I wouldn’t be surprised to see those numbers become more extreme tomorrow. For the record, I have a fair number of bull put spreads on with short strikes from 570 to 520. Given the oversold state of the stochastics, my expectation is that a spike down on poor earnings will be met by buying, and that my overall positions will be profitable – that is, poised to expire worthless – at the May expiry. If the numbers are good tomorrow, and the stock opens sharply higher on Wednesday, I’ll probably look to take profits on the more vulnerable (that is, higher) strikes. Either way, it will be entertaining, and I’ve sized the position so that even a move that goes completely against me will be annoying rather than disastrous.

 As I’ve mentioned on occasion, although it’s my pleasure to offer my musings here from time to time out of respect for Toddd and what he does – and out of gratitude for all that he’s tried to teach me – my day job is in FX, where I work on the trading desk of a large bank. As a market maker, I get to see a wide variety of traders on the other side, ranging from the most sophisticated institutional investors to smallish corporations that occasionally need to exchange currencies. Today I saw some early buying of Dollars against the Swiss Franc in response to a report that a Swiss company, Nestle, is buying a division of Pfizer for a price that was reported to be $11.9 billion.

Now, it is the case that Nestle’s home currency is the Swiss Franc, and that Pfizer very likely wants to be paid in Dollars. However, I’ve worked on a number of M&A deals over the years, and it is almost 100 per cent certain that all or nearly all of Nestle’s FX requirements were covered well prior to the announcement. The investment bank advising the acquirer normally expects to get the (potentially lucrative) FX business associated with the transaction, and the first step will often be to design a structure in which the purchasing company buys (in this case) a USD call/CHF put and pays for it by selling a USD put/CHF call, so that there’s little or no premium payment. This sets an upper limit for what the company will have to pay, and provides a chance to buy discounted Dollars if the put is exercised.

It’s also true that Nestle already has sizable operations in the U.S. Since it has large and ongoing USD cash flow, it can easily arrange for a loan in Dollars that will be repaid with revenues earned in the U.S. This has the additional benefit of hedging those flows, removing the exchange rate risk involved in converting them back into Swiss Francs. Given that the Swiss National Bank is working overtime to attempt to weaken the Swiss Franc in order to aid the country’s exporters, Nestle might even be able to approach the central bank for the needed Dollars, selling CHF in return. In any case, a glance at the daily chart of USD/CHF offers no indication that anyone has been buying $12 billion or so. My guess, consequently, is that a Dollar loan has been or will be obtained, with little or no direct impact on the FX market. Anyone who got excited by the news and decided to grab some USD/CHF may make some money, but it will be the result of luck. That is one boring chart, largely because the Swiss National Bank has put a floor under the more important EUR/CHF rate. If the Swiss can’t appreciate against the Euro, its scope to do so against  the Dollar is also quite limited.

As noted, just a few thoughts; here’s hoping that every one here is doing well. Best of luck tomorrow, with AAPL or whatever other instruments you might be be involved with.

P.S. It’s now 10:40 EST on Tuesday, and I just received this message from my Swiss trader: “Lots of stop losses below in USD/CHF .9090/80 from those who got long on the Pfizer/Nestle deal news.” “Nuff said.

About the Author Brian Keith


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