IVolatility Trading Digest™ Blog

Monday May 05, 2008

Volume 8, Issue 18,
Ocean Shipping

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

In IVolatility Trading Digest™ Volume 8, Issue 15, Momentum Waves, dated April 14, 2008, we offered suggestions for two companies in the ocean transport sector. We noted this group was not a momentum favorite, but with improving fundamentals this could change and the group could return to favor once again.

We suggested DryShips, Inc. (DRYS) at 65.41, now 89.86 in three weeks, while Genco Shipping & Trading Ltd. (GNK) rose from 58.43 to 73.23.

Since the momentum is returning and the chances are good it will continue to improve for the next few months we are adding some additional suggestions in this issue. Then we will update the Takeover File with a look at Yahoo! First a brief review of the markets.

Market Review

S&P 500 Index (SPX) 1413.90. Now that the SPX has closed above the previous 1400 resistance we can declare with some confidence that the double bottom formed on March 17, 2008 at 1256.98 is the final bottom. The measuring objective for the double bottom is up at 1543 and there is no overhead resistance until 1500 and then 1525 before reaching 1543.

The CBOE Volatility Index (VIX) 18.18. The VIX trend continues lower adding support to the market advance. But the call volume rose to 130,000 contracts on Friday with the open interest expanding to 800,000 contracts. In the recent past this has been a leading indicator of a short-term market decline. The VIX options buyers are giving us a short-term cautionary warning.

The US Dollar Index (DX) 73.50 continued higher crossing above and closing above resistance at 73.194 thereby setting off a double bottom pattern and establishing a new upside measuring objective at 75 which may take 30-60 days to reach. This portends more trouble for gold, silver and the commodity group including crude oil. It is supportive for equities and they should continue higher.

As for market breadth, our indicator, the NYSE McClellan Summation Index accelerated once again adding 153.53 for the week closing at 209.32, further supporting the bullish view.

Strategy

The US Dollar Index (DX) is telling us it is likely to continue higher so we suggest reducing, closing or hedging positions in the commodity sensitive sectors including gold, silver, agriculture, agricultural chemicals, oil & gas and oil services. In addition to the increasing dollar some of these sectors are seasonal and are due for a seasonal decline.

For these three recent suggestions we would close them along with any others in the sectors mentioned above and then beat the drums.

CBOE Volatility Index (VIX) 18.18. When we suggested this bear put spread in IVolatility Trading Digest™ Volume 8, Issue 14, Bottom Fishing, dated April 7, 2008 the VIX was 22.45 and the long Jun 22 ½ put, short Jun 20 put had an indicated debit of .8250. The current indicated value of this spread is 1.65 for a four-week 100% gain. The increasing call volume and open interest detailed above leads us to conclude we are near a short-term bottom for the VIX and we should now close this spread.

McMoRan Exploration Co. (MMR) 27.71. We suggested MMR in IVolatility Trading Digest™ Volume 8, Issue 15, Momentum Waves, dated April 14, 2008 when it was trading at 21.19. The April 20 put sold at .50 expired worthless. The May 20 put sold at 1.625 is now .20 offer, no bid. We will let this one expire as well. The long May 20 call short the May 25 call bull spread was 1.80 and is now indicated 4.45 for a 147% three-week gain.

Potash Corp. of Saskatchewan, Inc. (POT) 186.61. When we suggested POT in IVolatility Trading Digest™ Volume 8, Issue 11, Ben’s Magic Show, dated March 17, 2008 it was trading at 160.46. It then traded as high as 215.97 on April 23, 2008 before correcting. Originally the long Jun 160 call short the Jun 170 call spread was 4.40. Now the indicated value of this bull call spread is 7.05 representing a 60% gain in seven weeks.

IVOLopps™

Ocean Shipping

The ocean shipping industry consists of four general categories, bulk carriers, container ships, tankers and the newest category LPG/LNG carriers. Capital Link Shipping is a good source of fundamental information for the shipping group.

As we wrote in the first paragraph above we suggested DryShips, Inc. (DRYS) 89.86 when it was trading at 65.41. The suggested spread, long Jun 70 call with a short June 75 call was 1.70. This spread is now 3.90 representing a 129% gain in three weeks. Since we are probably still early in the momentum of the group we suggest keeping this position, but we would roll it out to the July option series on the expiration of the May options in about two weeks.

Genco Shipping & Trading Ltd. (GNK) 73.23 was 58.43 when we suggested the Jul 65/70 bull call spread. The price of this spread has increased from 1.325 to 3.10, a 134% gain in three weeks. We also suggest keeping this position open.

Now we have two new suggestions in the tanker group.

Last year about this time we read reports that VLCC tankers we being chartered with the option to extend the charter periods beyond the voyage term to use them a temporary storage. Now there are reports from charter brokers that VLCCs are once again being used for storage. This is significant as it reduces the available tonnage and prevents a sharp decline in charter rates. With rates for most routes in excess of 100K per day this is a favorable development and we could see higher rates yet to come.

Overseas Shipholding Group Inc. (OSG) 79.71. New York based OSG) is a bulk shipping company, engaged in the ocean transportation of crude oil and petroleum products. As of December 31, 2007, the company owned or operated a fleet of 112 vessels (aggregating 12.2 million dwt and 432,400 cubic meters) of which 93 vessels operated in the international market and 19 operated in the U.S. Flag market. Currently they are paying a predictable .313 per share quarterly dividend. With a current Historical Volatility of 31.65 consider this bull call spread.

Trade Plan

DR: Freight rates are now high and may go higher as VLCCs are being used for storage by the major oil companies reducing the available tonnage for charters. Seasonally this is a favorable period that extends until the middle of July.

SU: Unwind the spread on a close back below 70, as this would break the current uptrend.

Buy OSG OCT 85 call OSGJQ 6.15 IV 37.85 Delta .4597

Sell OSG OCT 90 call OSGJR 4.35 IV 36.76 Delta -.3665
Debit 1.80 Position net delta .0932

The position has a maximum potential gain of 3.20 with a limited and defined downside risk.

Frontline Ltd. (FRO) 58.24. Hamilton, Bermuda based FRO claims to be the worlds largest Tanker Company with a fleet of 77 oil tankers, including oil/bulk/ore (OBO) carriers ranging in size from 135K dwt to 311K dwt.

The stock has recently broken out above its 40-52 trading range, now 58.24.

Frontline pays out much of its cash earnings in dividends. The last dividend paid in February for the fourth quarter was 2.00. For the year through February they paid 8.25. Based upon the current price this would be a 14% yield if it can be sustained.

Frontline management just announced they are contracting for the purchase of four 320,000 dwt VLCC newbuildings to be delivered in 2011. Management says they were ordered because of a positive market outlook and the deal can be executed and financed without significantly reducing their dividend capacity in the short to medium term.

The average freight rate in the first quarter 2008 is a good bit higher than in the fourth quarter 2007. Chances are the dividend for the first quarter will be higher than the 2.00 paid in February and chances are the stock is being bought for the dividend and will decline when paid.

They are scheduled to report estimated earnings of 2.33 on May 29, 2008. We will know the dividend amount at that time. Since it is a almost a month away the stock could well rise a good bit between now and then on speculation of the dividend amount to be announced. With a current Historical Volatility of 32.29 consider these ideas.

Trade Plan:

DR: As detailed above.

SU: A close below 50 (not considering the upcoming dividend) along with a collapse in the freight rates to under 100K on the AG-Korea route (now 147K per day) is the unwind/stop.

Here are two suggestions:

Buy 100 shares of FRO at 58.24

In three weeks sell the June 65 call FROFM now priced at .425 with an implied volatility of 32.36
Or
Buy FRO Jun 60 call FROFL 1.70 IV 35.25 Delta .4014
Sell FRO Jun 65 call FROFM .425 IV 32.36 Delta -.1385
Debit 1.275 Positions net delta .2629

The position has a maximum potential gain of 3.725 with a limited and defined downside risk.

Takeover File Update

Yahoo! Inc. (YHOO) 28.67.

On Saturday Microsoft withdrew the takeover bid after failing to agree on an acceptable price.

We would now expect to see the uncertainty premium reflected in the implied volatility of the options decline and the stock return to the lower 20’s.

As we outlined in IVolatility Trading Digest™ Volume 8, Issue 16, More Income, dated April 21, 2008 we were looking forward to a long stress free summer with high implied volatility and many opportunities to sell premium. We will now be assigned stock and will have to work all summer with little time for the beach. Needless to say we are not happy with Microsoft and Steve Ballmer.

Next week we will review the open suggestions and consider some recovery ideas.

Previous Issues and Reader Response Request

All previous issues of the Digest can be found by using the small calendar at the top right of the first page of any Digest Issue. Click on any underlined date to see the selected issue. As usual we encourage you to let us know what you think about how we are doing and what you would like to see in future issues. Send us your questions or comments, or if you would like for us to take a look at a specific stock or ETF just let us know. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.

Comments:

I enjoy reading your column every week and have a question: For debit spreads, how do you guys select your strike prices? Risk/reward, technical analysis targets, etc.? Keep up the good work!

Posted by Ben on May 05, 2008 at 04:44 AM EDT

Ben, Thanks for your kind comment on the debit spreads. Since debit spreads are directional trades, either up for bull call spreads or down for bear put spreads we are of course concerned with the near term trend and we use many traditional tools for the selection of the underlying stock. As for the strike price selection we will attempt to find a combination that gives us an edge, i.e. we want to sell the more expensive option and buy the less expensive as measured by the implied volatility of the options. In some cases there is no edge between the two option prices, but there may still be an edge with respect to the Historical Volatility of the stock. Applying the same concept as the casino operators, if we can consistently have the edge, and minimize our mistakes in the long run we will make money. If we are near a pivot we prefer out-of-the-money spreads with considerable time to expiration. If the stock is in a defined trend then spreads that are closer to the money can be considered. Look at the net delta of the spread and see if you are comfortable with this level of risk. Also consider the net gamma (rate of change of delta) of the spread, ideally we would like to find a combination where the gamma of the long leg is greater than the gamma of the short leg. If we have the direction right then we would like to see our long leg gain delta faster than the short leg is losing delta. We use our service Advanced Options for these values in combination with our Advanced Historical Volatility service. If you are not familiar with these services sign up for a trial period and take a look at the data we provide for options traders at very reasonable prices. Jacktrader

Posted by Jacktrader (66.182.123.195) on May 06, 2008 at 01:44 AM EDT

Great write up in response to Ben on debit spreads. That, along with your comments responding to Wimal on his questions on the April 14th digest, and I am sure more to come, are very worthwhile study. Many thanks for your time.

Posted by David on May 06, 2008 at 07:46 AM EDT

I was with you in thinking that the YHOO IV would drop off after MSFT walked away, but it hasn't dropped off. It seems like the worst case drop for YHOO stock now would be in the 23-24 range based on what happened Monday morning. With the IV still high, maybe some of those income producing ideas are still worth consideration???

Posted by Jeff on May 06, 2008 at 10:09 PM EDT

David, Thank you for taking the time to send a comment. We appreciate your feedback. While we try to keep it as simple as possible we also try to include enough detail to make it useful. Jacktrader

Posted by Jacktrader (66.182.123.195) on May 07, 2008 at 12:34 AM EDT

Jeff, Thanks for the YHOO comment. You are right the implied volatility remains higher than we would have expected based upon the news releases. The combination of the options pricing and relative modest price decline of the stock seems to be suggesting there could still be some life in the negotiations. Jacktrader

Posted by Jacktrader (66.182.123.195) on May 07, 2008 at 12:53 AM EDT

Do we have any clue or opinion as if MDTL has a 1st qtr softer loss than before??? To be anounced fefore expire. I noticed that this am the 10.00 July calls have sold 1,969 @1.15 and the puts are selling @ 2.50. I have the May puts sold. That July 2.50 put sure looks inviting!! Al Boling

Posted by Al Boling on May 07, 2008 at 11:39 AM EDT

I appreciate IVolopps and the alerts. If taken action,in a timely manner, those spreadtrades could be profitable with known risk limits. I would like to see more of Bull Put spread trades especially on stocks that a trader wants to own with great long term fundementals. Jey Pillai

Posted by Jey Pillai on May 07, 2008 at 01:49 PM EDT

Al, Thanks for the MDTL question. We have no information on the earnings report other than it will be after the close next Monday May 12, 2008. They did secure a commitment for an equity facility that they announced on April 28, 2008. If they need to sell stock it will be dilutive and the price will decline. We do see that the implied volatility index has declined from 121.79 a month ago to 101.63 now. However, there is considerable skew between the puts to the calls. The puts are being bought for protection and the prices have been bid up accordingly. The July 10 puts with an implied volatility of 120.56 does look tempting, but we would suggest waiting to see the earnings report and see if we are going to be assigned on the short May 10 puts before increasing the position size. Jacktrader

Posted by Jacktrader (66.182.123.195) on May 08, 2008 at 12:22 AM EDT

Jey, Thanks for the comment on the spread trades. We will add some bull put spreads to the list. We think you have it right about selling puts on good stocks with good fundamentals especially if the puts are expensive. Jacktrader

Posted by jacktrader (66.182.123.195) on May 08, 2008 at 12:30 AM EDT

I would like to know if iVolatility can help me to calculate the theoretical price for a spread if the underlying stock trades at a given price. Here is an example; CALM closed at 33.09 June 30 Puts at 0.50 June 25 Puts at 0.15 Say, I want to set a contingent order to buy the 30/25 Put Bear Spread tomorrow *IF* CALM trades at 30.85 (2.24 below the previous closing price). The current spread cost is 0.40 (0.50 minus 0.15). How do I estimate the limit price to buy this spread if the stock drops to 30.85 the next day ? Since this is only for the *next* day, theta will be negligible but the other Greeks will change in line with price. Since I am not watching the market during trading hours, I can place these contingent orders through my broker if I can estimate the spread cost at a different price. Your suggestions are appreciated.

Posted by Wimal on May 08, 2008 at 11:39 AM EDT

Wimal, Thanks again for the question on pricing spreads. We have covered this in previous exchanges, but will go over it again if we did not make it clear. The key is to calculate the net delta of the spread. The primary reason that we include the Position net delta with the suggestions is for readers to adjust the spread pricing the next day to the market price of the stock. For example, if the Position net delta is .2000 and the stock is trading 1 point higher the next day adjust your spread order up .20. As a practical matter you may want to adjust the order up a bit more to allow for the difference between the bid and offer prices, say to .25. You can calculate the spread position net delta after the close and then give your broker the limit order for the next day. Also remember it is only good for the next day and is only an estimate of were the spread would likely trade assuming all of the other variables remain constant. You will need a data source for the delta calculations and we recommend our Advanced Options page. Jacktrader

Posted by Jacktrader (66.182.123.195) on May 09, 2008 at 12:31 AM EDT

Permalink Comments [12]

« Volume 8, Issue 17,
Big Fish | Weblog

IVolatility Trading Digest^TM Disclaimer
IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter constitutes a recommendation to buy or sell any security. Before entering a position check to see how prices compare to those used in the digest, as the prices are likely to change on the next trading day. Our personnel or independent contractors may own positions and/or trade in the securities mentioned. We are not compensated in any way for publishing information about companies in the digest. Make sure to due your fundamental and technical analysis homework along with a realistic evaluation of position size before considering a commitment.

Our purpose is to offer some ideas that will help you make money using IVolatility. We will also use some other tools that are easily available with an Internet connection. Not a lot of complicated math formulas but good trade management. In addition to Volatility we use fundamental and technical analysis tools to increase the probability of success and reduce risk. We prepare a written trade plan defining why the trade is being made, what we call the "DR" (determining rationale) and the Stop/unwind, called the "SU".

IVOLopps^TM
In this section which we call IVOLopps^TM (IVolatility Opportunities) we will focus on recommendations that should be made now, or Action Now! For many event driven opportunities volatility will be abnormal for very short periods of time so action is recommended without delay. Our assumption is the trade will be made the next day.

IVOLalerts^TM
Our next section we call IVOLalerts^TM (IVolatility Alerts). These recommendations require some additional time before being made. Often we will be waiting for confirming fundamental or technical developments before making these trades.