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Sirius

The term "Dog Days" was coined by the ancient Romans, who called these days caniculares dies (days of the dogs) after Sirius (the "Dog Star"), the brightest star in the heavens besides the Sun. Popularly believed to be an evil time "when the seas boiled, wine turned sour, dogs grew mad, and all creatures became languid, causing to man burning fevers, hysterics, and phrensies" - Brady’s Clavis Calendarium, 1813.

According to The Book of Common Prayer (1552), the "Dog Daies" begin on July 6 and end on August 17.

Using their model the Romans could have explained events in the financial markets during the past two weeks. The markets were indeed boiling and no doubt some wine turned sour but it all seems to have reached a crescendo with multiple key reversals on August 16, 2007. The major equity indexes reversed up, the implied volatility indexes along with the dollar index reversed down and then the next day on August 17, 2007, the Federal Reserve cut the discount rate confirming that the Dog Days of Summer were over – just in time.

While there is likely to be a retest of the lows in the next few weeks the major long term upward sloping trend lines, from the March 2003 lows, remain unbroken.

Strategy

Market Implied Volatilities reversed along with the indexes and they are heading lower once again. A review of the Top 200 Stocks by volume and open interest (on our Home Page) revealed that the IVs of most have already returned to their normal range. If your strategy was to sell volatility and you have not done so by now you are probably too late. Now the best course of action is to remain focused on the strong groups for long strategies and the weakest groups for shorts. In the homebuilders and financials start watching for signs of developing reversal patterns as the existing shorts begin the covering process. The implied volatilites for some of these stocks have returned to their normal ranges. Watch for head and shoulder as well as double bottom patterns.

Best Calendar Spread

We feature a calendar-spread scan on our Home Page. This is Friday’s scan.

Tellabs Inc. (TLAB) now 10.85 with a Historical Volatility of 41.77

Calendar spreads also called horizontal spreads offer a theoretical advantage when the near term options are selling at a higher price than the deferred option. In this spread example the Sep 10 call at 1.05 has an IV or 46.14 while the Dec 10 call at 1.50 is 35.48. This seems to support the advantage conclusion. However, in the case of takeover rumors the premium of the near term options could well be justified. Remember a large move in the underlying will hurt the calendar spread. Additional research is required.

In IVolatility Trading Digest™ Volume 7, Issue 25, dated July 30, 2007 we noted,

On Monday July 23, 2007 news of a takeover was being circulated and it follows: TheStreet.com said Nokia Siemens Networks (NSN.UL: Quote, Profile, Research) was offering about $16 to $17 a share for Tellabs, citing a source familiar with the deal. That would be a 35 percent to 43 percent premium to Tellabs' closing price on Friday of $11.85 -- a price that many analysts said looked too steep.

Credit Suisse also called the reported price "expensive," but it said a deal would represent a "strategically and financially sound" move for Nokia Siemens by strengthening the company's position in North America and bolstering its portfolio of wireline gear.

Since Tellabs has an 80 % market share of the equipment that manages the wireless backhaul networks of the North American carriers it seems to make compelling target for one of the European carriers such as Nokia Siemens, considering their higher valued Euro along with the reduced market price of TLAB.

Once again let’s look at the Put/Call volume ratio chart to see what additional information we can find.

The put-to-call ratio is computed as the total number of puts traded each day divided by the total numbers of calls. It is one of the best measures of market sentiment and it helps to determine whether option buyers are predominantly bullish or bearish and whether that relative bias is intensifying or diminishing. A rising ratio suggests a bearish bias while a falling ratio indicates a bullish bias. A high put-to-call ratio signals a market bottom and low number signals a top. If the ratio falls lower than 0.3, this implies euphoria, or as in this case, takeover speculation.

It seems very likely that Nokia Siemens Networks could see the current weakness in the equity markets as an opportunity to proceed with their offer in the hope of completing the deal at a somewhat lower price.

This would seem to make the calendar spread somewhat less desirable than it would appear.

As an alternative consider this call ratio backspread suggestion:

Trade Plan

DR: Takeover target.

SU: Below the most recent support at 10.

Sell TLAB Dec 10 call TEQLB 1.40 IV 35.48 Delta -.7230
Buy 2 TLAB Dec 12 ½ calls TEQLV .80 (.40 x 2 ) IV 33.61 Delta .5862 (.2931 x 2 )
Credit .60 Position net delta -.1368

While reviewing the list of the Top 200 Stocks by volume and open interest we made some additional discoveries worth considering.

High Volatility

We have two categories of high volatility. The first, which we refer to a Type I is characterized by a positive volatility spread. These are the ones we like for selling puts and for doing covered calls.

Here is a Type I example:

The IV Index Mean has been rising faster than the Historical Volatility. It is now at a high level and has created a well-defined spread. FMCN is a Shanghai company offering electronic display advertising. Currently priced at 40.01 with a Historical Volatility of 56.87. Selling the Sep 35 put QOHUG at 1.25 with an IV of 75.88% would be an example of this type of volatility trade. An alternative covered call strategy would be the purchase of 100 shares of stock and the sale of the Sep 45 call QOHII at 1.475 with an implied volatility of 70.19%.

The second category of high volatility opportunities is those referred to as Type II. These are characterized by the lack of a positive volatility spread. In this case both the Implied Volatility and the Historical Volatility have risen to a high and most likely unsustainable level. In this case we are expecting both to decline.

Here is an example of Type II high volatility:

In this case we can see that both have risen and are now declining. We expect a return to the 25-30% range. PBR engages in the exploration and production of oil in Brazil. Currently priced at 59.28 with a Historical Volatility of 48.31. An example of the put sale is the Sep 55 put PBRUK .925 with an IV of 40.14. The alternative covered call would be the purchase of 100 shares of stock and the sale of the Sep 65 call PBRIM .80 with an IV of 38.58. We are expecting both volatilites to decline with the rising stock price.

Low Volatility

Now for a low volatility example that we found while reviewing the Top 200.

Here we have a declining volatility pattern for both IV and Historical. The IV spikes are associated with quarterly reporting. eBay, Inc. provides online marketplaces for the sale of goods and services. Currently priced at 34.08 with a Historical Volatility of 25.06. The IV for the calls are 26.14. This is a stock that seems to have lost its growth momentum. The suggestion here is to use a call ratio backspread with the expectations that the stock will rise and the IV will rise again going into the next reporting period. In order to capture the rise in volatility we would plan to sell the position just before the next reporting period. In the last two reporting periods the stock has risen prior to reporting. A call ratio backspread is a credit spread with an extra long call. The margin requirement is the same as a credit spread while cash pays for the extra call. This is a low cost leveraged trade.

Consider this suggestion:

Sell EBAY Jan 35 call XBAAG 2.70 IV 32.96 Delta -.5319
Buy 2 EBAY Jan 40 calls XBAAH 2.00 (1.00 x 2 ) IV 31.16 Delta .5414 (.2707 x 2 )
Credit .70 Position net delta .0095

Again we encourage you to let us know what you think about how we are doing and what you would like to see in futures issues. If you have questions or comments or requests just let us know. If you have some trading ideas that you would like to share with us then use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.