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IVolatility Trading Digest™ Blog
Monday July 28, 2014
Volume 14 Issue 30
4 Rotation Challenge Ideas
4 Rotation Challenge Ideas - IVolatility Trading Digest™
Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Anyone trying to follow various equity sectors in an effort correlate a normal market cycle to the economic cycle knows how challenging the task has been for the last few months. Perhaps the best example is the transportation sector near its all time along with consumer staples, utilities and industrials having now started declining. Transportation, normally considered an early expansion group, while consumer staples and utilities are early contraction groups. The continuing flow of funds into Treasury Notes and Bonds adds complexity and suggests it is more about traders rotating out of groups that have been doing well into those that had been lagging. Take last week for example, the industrials declined while China broke to the upside after reporting favorable economic news.
After a short market review along with two related important developments last week we offer some ideas for participating without putting all the emphasis on getting any sector direction right. First iShares China Large-Cap (FXI) for the China breakout, then we add our opinion about Amazon.com Inc. (AMZN). Next, we turn to an implied volatility idea for Walgreen Co. (WAG) and finally a trend continuation idea for Celgene Corporation (CELG).
S&P 500 Index (SPX) 1978.34 up .12 for the week but the story is about the formation of a symmetrical continuation pattern set off by Tuesday's 9.90 advance. This reliable pattern set the upside measuring objective at just under 2004. However, Friday's 9.64 decline appears to have thrown cold water on the breakout. Adding further discomfort to the bullish view, the iShares Russell 2000 (IWM) 113.60 gapped lower renewing thoughts about a potential double top, or a Head & Shoulders Top with a measuring objective at 95 that would be set off on a close below 108.
CBOE Volatility Index® (VIX) 12.69 no longer at all time lows appears to have found a new midrange around the 12 level while the VIX futures premium closed the week in the yellow caution zone at 8.31%.
Other noteworthy developments:
US Dollar Index (DX) 81.03 breaks out above 80.75, next stop 81.25 and then 81.50, above the highs of last November. Some analysts suggested China Treasury buying could be the reason for higher note and bond prices as well.
Crude Oil WTI (CL) 102.09 basis September, The Commitment of Traders report dated July 22 shows net long speculators declining again making it four weeks of decline with the latest at - 28,159 the most while perhaps more important was the decline in total interest by a staggering -127,593 contracts. One way to measure trend momentum is to watch open interest since it needs to keep expanding to sustain the move. For a gage as to when the trend may be changing watch for a sustained decline in open interest indicating existing long liquidation to existing shorts who begin covering. Until July 1 open interest increased, but the July 8 report shows a 30,764 decline, then it advanced 971 on July 15 before the latest -127,593 decline.
It could be premature to declare the seasonal crude oil advance has run its course, but it could also be the first indication that speculative funds are exiting this trade and moving on, perhaps to China equities.
Where's the money going?
Small capitalization stocks, industrials, and perhaps even consumer staples and utilities are being sold so perhaps the money is moving into China equities as evidenced by the breakout of the iShares China Large-Cap Index ETF along with others including the Shanghai Stock Exchange Index 2126.61 that broke out above 2080 Thursday.
If so here is one idea,
iShares China Large-Cap (FXI) 40.19
After trading sideways around 38 for two months, it broke out last Tuesday. However, the previous high of 40.32 made last December 2 makes a tempting target for sellers in the event this is just a trading move up from March lows.
The current Historical Volatility is 15.42 and 7.29 using the Parkinson's range method, with an Implied Volatility Index Mean of 17.89 up from 16.21 the week before. The 52-week high was 27.52 on March 3, 2014 while the low was 15.64 on June 30, 2014. The implied volatility/historical volatility ratio using the range method is 2.45 so the option prices are expensive relative to movement of the stock. The put-call ratio at .30 was bullish. Friday's option volume was 38,829 contracts traded compared to the 5-day average volume of 114,960 while the ETF traded more than 18 million shares.
Since there could be some selling at the previous high around 40, more time will allow it to overcome any resistance. Consider this long call spread.
Using the ask price for the buy side and the mid for the sell, the debit would be .52 and 26% of the distance between the strikes. Use a close back below 38 as the SU (stop/unwind).
Growth at any price
Amazon.com Inc. (AMZN) 324.01.
The growth at any price poster child stumbles. Perhaps the bulls run out of patience after AMZN reported a loss twice the market expectation and guided for an even larger loss in the current quarter. Based upon trailing 12-month earnings the price to earnings ratio computes at 505 with a price to earnings growth rate of 90. Yikes!
After Friday's 34.60 point decline there could be more to come. Will the longs finally sell out hoping to replace it with Alibaba when it becomes available?
The current Historical Volatility is 39.77 and 21.51 using the Parkinson's range method, with an Implied Volatility Index Mean of 26.14 down from 35.85 the week before. The 52-week high was 49.52 on April 10, 2014 while the low was 21.98 on September 16, 2014. The implied volatility/historical volatility ratio using the range method is 1.22 so option prices are surprisingly inexpensive relative to movement of the stock with a bearish 1.22 put-call ratio. Friday's option volume was 399,138 contracts traded compared to the 5-day average volume of 132,800 contracts.
Since the short term is down a bearish call credit spread and a bearish put debit spread should be an inexpensive combination without much risk of time value loss.
First the call credit spread,
Using the ask price for the buy side and the mid for the sell the credit would be .75
Now for the put,
Using the ask price for the buy side and the mid for the sell the debit would be .26
Net position credit .49, use a close back above 340 as the SU (stop/unwind).
Top of the IV Range
Now shifting gears consider this volatility idea.
Walgreen Co. (WAG) 73.29
Friday's option implied volatility, near the top of its 52-week range puts it in first place in this ranker category, while the stock price is near the middle of its range between 70 and 76 that started in May.
The elevated implied volatility apparently stems from the controversy surrounding the proposed Alliance Boots tax inversion transaction and not related to an upcoming earnings report since they just reported 3Q earnings June 24.
The current Historical Volatility is 22.35 and 17.14 using the Parkinson's range method, with an Implied Volatility Index Mean of 35.88 up from 34.03 the week before. The 52-week high was 36.27 on July 22, 2014 while the low was 18.70 January 7, 2014. The implied volatility/historical volatility ratio using the range method is 2.09 so the option prices expensive relative to movement of the stock with a neutral .7 put-call ratio. Friday's option volume was 32,708 contracts traded compared to the 5-day average volume of 43,560 contracts.
Presuming it stays with the 70-76 price range, consider this Iron Condor, selling both sides out-of-the-money.
Using the ask price for the buy side and the mid for the sell the credit would be .48.
Once again, using the ask price for the buy side and the mid for the sell the credit would be .55.
Combined the credit would be 1.03, so even allowing for commissions it should produce a good return on investment considering a 250 margin requirement. Use closes below 70 or above 75 as the SU (stop/unwind/ adjustment) levels.
Celgene Corporation (CELG) 87.16.
Even with all of the sector rotation, now including back into China, it doesn't seem very likely quality biotech companies will decline very much and since they just reported earnings it looks as if it will maintain its current uptrend that began with the last quarter report on April 24.
The current Historical Volatility is 29.93 and 23.95 using the Parkinson's range method, with an Implied Volatility Index Mean of 26.22 down from 29.55 the week before. The 52-week high was 40.59 on April 15, 2014 while the low was 21.34 on June 13, 2014. The implied volatility/historical volatility ratio using the range method is 1.10 so options are reasonable relative to movement of the stock with a bullish .32 put-call ratio. Friday's option volume was 14,577 contracts traded compared to the 5-day average volume of 19,420 contracts.
Consider this bullish put credit spread.
Using the ask price for the buy side and the mid for the sell the credit would be .32 with a 350 margin requirement. Use the low of 84.25 reached when they reported on July 24 as the SU (stop/unwind).
The suggestions above use the closing ask prices for the buys and middle prices for the sells presuming some price improvement from indicted prices is possible for liquid stocks. Monday's option prices will be somewhat different due to the time decay over the weekend and any price change.
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Sector rotation continues creating confusion compared normal market cycles and seems to be more about trading between sectors than an indication of future economic activity. Now funds are flowing back into China once again adding to the rotation analysis challenge. In the meanwhile, look for low risk opportunities with low time decay in the current low volume summer trading environment.
We now offer daily trading ideas from our RT Options Scanner before the close in the News section of our home page based upon active calls and puts with increasing implied volatility and volume.
Follow us on twitter for more ideas from our scanners and other developments.
In next week's issue, we will update our market indicators and report again on the sector rotation.
Finding Previous Issues and Our 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. Another way to find them is the Table of Contents link in the blog section of our website.
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IVolatility Trading DigestTM 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".