Watching XLF Price and IV Action

The financial sector stock de jour is BSC today – unless of course it’s WM. With anxiety over ABK and MBI seemingly on the back burner at the moment and TMA and LEH suddenly so yesterday, which financial stock is going to set the tone for the market? My take is that since one tipping domino is unlikely to be contained, I am continuing to focus on the broad sector ETF, XLF.

Just a week ago today, I posted a one year chart of XLF showing price and implied volatility; in the interim, a great deal has changed, with the bears and the news flow dictating the action. From a technical standpoint, just yesterday XLF took out the 52 week high (47.99) in implied volatility from November 8^th and the 52 week stock price low (24.11) from January 22^nd. The chart below zooms in on the last six months and shows that yesterday’s selloff generated a new stock price low of 23.50 and IV high of 54.52 – a fitting tribute to the eight year anniversary of the NASDAQ all-time high.

Going forward it is important to watch the action in newsmakers like BSC and the other financial headline makers, but XLF is an excellent proxy for the sector and a good way to keep focused on the forest instead of the trees. Note also the action in the XLF calls for March, April and June, which shows some significant bets are being made that today’s XLF-led market bounce will not be a one day affair. No matter how things play out, XLF should be an excellent tell. I suggest you watch it as closely as you do the broader indices and keep an eye not just on the price, but also on the IV and put to call activity.

MBI, Bond Insurers, and Volatility

One of the more interesting – and important – subplots to keep an eye on during the current market difficulties is that of the bond insurers. The two most prominent of these bond insurers, MBIA (MBI) and Ambac (ABK), are in the news today with reports that the New York Insurance Superintendent is trying to arrange a capital infusion from the likes of Goldman Sachs (GS), Merrill Lynch (MER), JPMorgan (JPM), Citigroup (C), and Wachovia (WB). Presumably, the Fed is doing some arm twisting and offering some financial incentives behind the scenes, as a failure to resolve the problems with the bond insurers would likely trigger systemic havoc and involve a long and expensive list of dominoes in the process.

Eric Dinallo, the New York Insurance Superintendent, was quoted earlier today as saying that while a rapid resolution is essential, ironing out the details of a bailout may take awhile. “It is important to resolve issues related to the bond insurers as soon as possible,” Dinallo noted, while cautioning “these are complicated issues involving a number of parties and any effective plan will take some time to finalize.”

While most investors should be thinking about the bond insurer issue in terms of its impact on the broader markets, there are some interesting plays on bond issuers themselves. As reported in 24/7 Wall Street, Goldman Sachs laid out some potential valuations under three different scenarios, ranging from the bond insurers’ being unable to raise enough capital to mollify the rating agencies to a situation where the capital raised enables the bond insurers to continue to operate as they had in a pre-crisis mode. Looking just at MBI, the valuation spread ranges from $6 to $48.

Investments don’t get much more speculative than this, as the chart from optionsXpress above shows. For the record, all February puts now carry an implied volatility of more than 200. While I am not going to recommend a specific trade here, there are some fascinating options spreads and ratio spreads to look at for those who believe that the Goldman scenarios and numbers are in the ballpark.