If this won’t make Cramer spit out that coffee, not sure what will (hat tip Kieran in the comments)

Direxion, a pioneer in providing alternative investment strategies to sophisticated investors, announced today that it will execute a 1-for-2 reverse split of the shares of Direxion Daily Mid Cap Bear 3x Shares after the closing of the markets on Wednesday, June 24, 2009. MWN shares will begin trading on NYSE Arca, Inc. (NYSE Arca) on a split-adjusted basis on Thursday, June 25, 2009.

No one’s exactly sure why they picked MWN to reverse-split first. It’s a $33 stock, and it’s way off the radar. But the implication is that more popular names like our friends FAS and FAZ will reverse split as well.

Clearly though 2:1 won’t do the trick for them, perhaps 10:1 would make more sense. Or better still, issue new one’s from scratch. There was also some thought about creating new one’s with longer reset periods, like say one month as opposed to 1 session. But alas, that becomes problematic too as we saw a month with a greater than 33.3% gain in financials as recently as March. In fact last time we ran numbers, we saw that if Direxion had issued monthly FAS and FAZ when they issued the originals, FAS would be lower than it is now and FAZ would have gone under zero.

And in other news, Finra has officially requested that Ultra ETF’s now only sell with a warning label.

The Financial Industry Regulatory Authority has reminded brokers and registered investment advisers about their fiduciary duties when selling ETFs that offer leverage, are designed to perform inversely to the index or benchmark they track, or both. In a notice posted to its Web site earlier this month, Finra reminded the brokers and advisers that these instruments are complex and typically unsuitable for retail investors who plan to hold them longer than one trading session.

“While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis,” the notice said. “Due to effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective.”

It goes on to note that if your Ultra ETF is still up 4 hours after you buy it, consult a physician. Do not operate heavy machinery if you buy and hold these.

And no, I have no idea what is in that picture, although it looks like something out of Sleeper.

Cue up the hyperanalysis, there’s some VIX OTM call trading going on……

The CBOE Volatility Index (.VIX) is down .28 to 20.88, as the S&P 500 (.SPX) has traded in a relatively narrow 10 point range Tuesday. The S&P 500 is nearly unchanged midday. In the options market, VIX July 42.5 calls are the day’s most actively traded contract, with more almost 87K traded. A lot of that volume is due to ratio spread trading, where a strategist was apparently bought 4 July 42 calls for every 1 (short) July 32.5 call. More than 25K July 32.5 calls have also traded today. They paid $1 per 1×4, according to a contact on the floor. The position is tied to VIX futures at 32.6 (might be a roll of long calls).

….If you are interested in more info like this, check out WhatsTrading.com

Options order flow has the most value when it goes against the grain of the stock. Like this one.

Houston-based oil driller Smith International (SII) is down $1.29 to $25.22, as a pullback in crude oil weighs on the drillers Monday. Crude was recently down $2.42 to $67.13 a barrel. However, while SII shares are falling, sentiment seems bullish. July 30 calls are the most actives, with 3,250 traded and 80 percent of today’s volume hitting ask-side. Another 1,290 July 37.5 calls traded, with 70 percent traded ask-side. While today’s volume doesn’t yet exceed open interest, ISEE sentiment data indicate that some customers are buying to open. Implied volatility is up to 62, from about 58 late Friday.

…If you are interested in more info like this, check out WhatsTrading.com

From Adam Warner at Daily Options Report:

One of the many complaints we have with CNBC is the misleading Causality Chain. The incredible desire to simplify every market tweak into 2 or 3 sound bite “reasons”. Is this such a big deal though? I mean anyone playing this game long enough would see right through it and realize it’s just never that simple and behave accordingly. Or would they? Interesting article here on The Frontal Cortex (hat tip Abnormal).

…….In one classic 1975 study led by Ellen Langer, male undergrads at Yale were asked to predict the results of coin tosses, a cliched example of a random event. Nevertheless, a significant number of the men believed that their performance improved through practice – they got better at calling heads or tails – and that distraction would detract from their performance. How did they justify this wishful thinking? As Langer notes, the men engaged in some sly cognitive filtering and consistently “overremembered past successes”.

Is Wall Street any different? The market, after all, is a classic example of a “random walk,” since the past movement of any particular stock cannot be used to predict its future movement. Given this inherent stochasticity, it’s silly to attempt to explain the daily movement of the market: such an endeavor is like analyzing a series of flipped coins, or trying to explain the payout patterns of a slot machine. We can construct theories – and some of these theories might even sound intelligent – but they’re ultimately futile attempts to stave off the flux.

What’s even more disturbing is that such errant explanations might actually cost us money, since they lead, inevitably, to over-confidence. (Those Yale undergrads vastly overestimated their ability to predict coin flips.) We become so convinced that the logical-sounding explanations are true that we forget we’re dealing with a random, inherently unpredictable system. The end result is too much trading.

Well some would disagree that past movement can not predict future movement. I mean there are certainly some sharp technicians around. But I think it’s more about knowing that….you really don’t know. A good techie will deal in probabilities, know he’s going to be wrong a certain percentage of the time, set stops and targets, et. al. The media (and it’s not fair just to blame CNBC for this) offers what sounds more like guarantees. Event A causes Stock Movement B.

The author throws in an interesting study. A group is divided into two parts. One subset invests with absolutely no information behind prices. The other group has full access to all news. The “news” group outsmarts themselves and returns only half the other group.

Now in real life it’s hard to imagine that less (knowledge) equals more. It’s really about knowing how to process that information. And the media just gives all the wrong lessons on that.

In our never ending quest to keep you as option-informed as possible, we will be adding some occasional content from WhatsTrading.com. Such as

iShares Brazil Fund (EWZ) December 35 put is among the most actively traded contracts in the first hour of Thursday’s session. 30K traded so far. Most of the volume is due to one spread, where a strategist bought 15K Dec 45 puts and sold 2X more Dec 35 puts. They paid $1 even for this bearish 1X2 put ratio spread. EWZ is up 17 cents to $53.17.

…If you are interested in more info like this, check out WhatsTrading.com

Not sure I’ve ever seen a single trade get this much press. But Don Fishback finds this reference to The Most Important Options Transaction Ever.

Can’t take it anymore. I’ve seen this too many times to not comment. Yesterday, a reporter for the Washington Post’s “The Ticker” wrote:

“At least one trader today placed a nearly $1 million bet that the VIX will rise above 45 by July, buying several thousand option calls.”

No, No, NO!

Just because somebody bought a million dollars worth of options does NOT mean that that person thinks volatility is going to 45. People buy options for 2 reasons: speculation and hedging. There is simply no way to know from the information presented in the article that this VIX call buyer was a hedger or a speculator. If the person was a hedger, then by definition they think the most likely event is that volatility is not going to go to 45, but they want to be protected in case it does. They bought volatility insurance!

It refers of course to the 20,000 lot of VIX 45-55 call spreads that went up last week.

Basically, following options order flow for directional clues is more art than science. When I was on the floor way back when, you kind of sort of kind of could get a feel for which players you wanted to follow and which ones you wanted to fade. But even that’s far from a path to riches.

And like Don says, who ever knows exactly what the player is doing overall. Even if you did, it’s still not a lock you want to follow them directionally or not. And let’s put this particular trade in perspective. Again, it was a low delta, way OTM call spread in the VIX. Remember it’s a VIX future, which this far out we figure will track about 40-50% of the VIX move. And even with the recent rally, the VIX still has a 31 full. Yes, you don’t need the VIX to actually go to 45 and above to win big on the trade. But as Don notes, 38 sure would work. We’re nowhere near that yet, and truthfully to get there you’d need to see the VIX in the 40’s as July would move to a discount.

So after all the fuss about Leveraged ETF’s causing their own late day melt downs and melt ups, is there any evidence it actually happens? I mean stocks have closed low and last or high and last forever. Has that pattern of accelerated as leveraged ETF’s gained popularity?

Just to refresh, the concept is that Third parties create these ETF’s for Direxion and ProShares, and those Third parties need to rebalance at some point each day in the direction the ETF is moving. The thought being that this large natural player was piling onto moves already in progress, in addition to hedgies and traders fronting them.

Michael Stokes of MarketSciBlog thinks that there’s not much to see here.

Now I don’t know if traders are seeing a surge in volume near the close (because I don’t trade intraday), I don’t know if leveraged ETFs are responsible for today’s higher levels of market volatility, and I don’t know if leveraged ETFs add potential systemic risk should the market make a really big move up or down (a’la Oct. 1987).

But I do know that, leveraged ETFs are not pushing the market to close at intraday extremes with any more frequency than has been observed historically.

….A simple test. The graph (click thru to see) ….. shows a 1-year rolling average of the % of days that the SPY closed in either the top or bottom 20% of its intraday range (blue, left scale) and/or the top or bottom 10% (red, right scale), from early 1993.

From today, the market has closed in the top/ bottom fifth of its intraday range (blue) 52% of the time, and in the top/bottom tenth 30% of the time, over the last year. And while this is slightly more than the average over the entire test of 49% and 28%, it’s still very much in line with historical norms.

I do believe volume patterns have changed since the popularity of these pups have increased, but that may be sector specific. Financials for example now regularly see the biggest surge in the last few minutes, whereas formerly volume peaked near the open. But it’s interesting that a basic study of price performance shows relatively minor tweaks.

Bottom line I found playing around with this trade is that it only really worked well in the financial sector. That is, if you bought SKF or FAZ in the last hour on an already ugly day, you likely had good flip if you sold it out at the bell. But a combo of everyone in the world gaming this thing, and financials just not moving nearly as much these days, seems to have ended the play

OK, I have no position in anything VIX related (trading VIX I mean), so I have no axe to grind.

So let me so note the “unusual” action at today’s open.

Just to refresh, today is VIX expiration day for June futures and options. They cash out based on a calculated opening settlement price. That settlement price is based on the opening quote (or trade) in each qualifying SPX series. How does an SPX series qualify? The CBOE goes up and down the line until they get two consecutive OTM series with no bids and no trades. So what happens on expiration day is that pretty much every series on the board in the appropriate cycle (in this case, July) will magically trade. Today’s open for example saw volume in every July put series down to the 400 strike.

What’s suspicious?

Well, the VIX “opened” down about 5%. Not sure where it will actually settle, but figure something like 31.
Meanwhile the SPX opened unch. and VXX, the trading proxy for 30 day VIX futures, has been unch. or higher all day. But even there, we see an odd trade as the largest one-minute volume was clearly a seller around 9:40, although that was very likely someone fooled by the VIX “print” a minute or so before that.

Look, we always see the SPX put volume on VIX expiration. But we generally see the VIX settle at a fair price. Today’s price does not look fair, but rather $1.5o too low or so. And remember the expiring options stopped trading yesterday and are cash settled today, so if, say, you were long June 30 calls (open interest 34,754) you had $150 taken from you per contract.

So what doesn’t move volatility? An low delta OTM call spread in a VIX product to name one thing.

What actually does? Well, stuff like this, from OptionsMonster last Friday (free sub. required).

If you’ve ever wondered where volatility goes to die, read on.

Two recent trades made bear important lessons on why the VIX is near its lowest levels in nine months.

In the largest of these transactions, 200,000 calls and puts on the iShares Silver ETF were sold, and only 75,000 calls were bought. It followed a similar trade on the SPDR Gold Shares exchange traded fund, where 33,000 options were dumped on the market while only 16,500 were taken back out in the form of purchases.

These kinds of trades set off a chain reaction that helps explain why the VIX has plunged in recent weeks. The volatility index is at its lowest levels since September.

As trades like this become more common, they are bringing volatility down. And as volatility subsides, traders bring in less premium selling out-of-the money options. They respond by selling even more options, which then depresses volatility everywhere. We noticed traders using this tactic with Gap options as well, selling twice as many GPS contracts as they bought. Since then the strategy has also been used on McKesson and Baxter International contracts as well.

I’d replace “strategy” with “order flow” above, as it’s not necessarily the same players buying and selling. But the point is spot on. As more call sellers come in, it sets off a daisy chain of bad news for volatility.

Market makers buy all the calls for sale and now find themselves long gamma. They react by lowering options bids across the boards, and attempting to make back some options decay in the stock via shorting into strength and buying into weakness. On the margins both the lower options volatility and increased liquidity in the stock serve to pressure realized volatility down. Which in turn may translate into even more interest in shorting options ever cheaper.

Rinse and repeat.

Index volatility depends partly on the volatility of the component stocks themselves. So as that decreases, it necessarily decreases index volatility.

And this is indeed much of what we’ve seen. At least until Monday as the VIX has turned up a bit.

He discusses the price action in SP500 over the last two weeks.  There has been a price change that has happened only six times since 1990 and four times something else has happened afterward.  Just from a quick and dirty statistical point of view, if something has happened four times out of six, the error is plus or minus two.  So I think of that “four times” as really “two to six times”.  That changes the strength of the conclusion for me.

Pretty rare occurrence this week, via Dr. Brett.

We had a 10-day closing high on Friday in the S&P 500 Index (SPY) followed by a 10-day closing low on Monday. It turns out that this is an unusual reversal. Since 1990 (N = 4895 trading days), there have only been six occasions in which this has occurred.

While six occasions is hardly a sample from which we can build a robust analysis, it’s worth noting that the market was down subsequently on a five and ten day basis on four of the six occasions by averages of -.22% and -.76% respectively.

It also speaks again to the utter lack of volatility in recent days. Really on two levels. You could see low daily volatility, but if it moves in one direction, the net effect is that if you just sat with a short gamma position, you would do poorly as the stock gradually moved away from the strike(s) you are short. So this goes beyond that. Not only did we see small ranges, but they offset each other for a full two weeks.