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Market Review

The rising Market Implied Volatilities are now forming well-defined upward sloping trend lines off the July 19, 2007 lows. They look to be going higher.

The US Dollar Index (DX) 79.62, basis cash, spent the entire week under the previous 80 support level. So far, the response by Gold has been tepid, with the Market Vectors Gold Miners ETF (GDX) 42.17, rising by just 2.4% from 41.17 last week.

In the Treasury market the 10-Year Note closed to yield 4.46%. Earlier in the week the yield reached a low of 4.30%. This inversion of the yield curve is one of many variables the Federal Reserve will most likely be taking into consideration before their Tuesday Open Market Committee meeting.

In the meanwhile, the Advance/Decline numbers continued to improve as the NYSE McClellan Summation Index moved 123.10 points higher to close at –246.97. This desirable upward trend is consistent with the improving NYSE equity market.

Strategy

From a strategy perspective we should position ourselves to benefit regardless of the news from the Federal Reserve on Tuesday. We suggest reviewing positions to see that we have both longs and shorts. If we have open spreads that have already made considerable moves we may want to close some of them and book the gains. China, Oil and Oil Service, Infrastructure, Agriculture, Agriculture Machinery and selected Casinos stocks with Macau operations are some long suggestions. On the short side the Homebuilders Mortgage Companies and retail are some areas to work on. In the event of positive news on Tuesday, some of the weak stocks may briefly turn higher providing another opportunity to structure delta negative positions.

More Chinese Companies

In IVolatility Trading Digest™ Volume 7, Issue 28, dated August 27, 2007 we introduced Focus Media Holding Ltd. (FMCN) 44.47, as an example of Type I High Volatility. Now we return to this company to fill in some of the blanks. Shanghai based Focus Media Holding Limited operates advertising networks using audiovisual television displays. They consists of commercial location networks, in-store networks, poster frame networks, mobile handset advertising networks, and outdoor LED networks. The commercial location networks includes flat-panel television displays placed in high-traffic areas of commercial buildings, such as in lobbies, near elevators, as well as in beauty parlors, karaoke parlors, golf country clubs, auto shops, banks, pharmacies, hotels, airports, airport shuttle buses, and in-air flights. With the Beijing Olympics coming next summer this company should be very busy.

Here are the volatility and price charts.

There is a positive volatility spread and now both volatility measures appear to be declining. In early July an unidentified short seller raised questions about certain related party transactions reported in 2005. The company has advised it will not file the required Form 20- F with the SEC until the matter has been investigated. As a result the company is delinquent with their filing requirements. You can see on the charts to the left the stock price decline and the volatility measures rose from early July. The current volatility relationship indicates a premium that has been priced into the options for this uncertainty. The positive volatility spread seen in the chart above is directly related to this development. From the price chart it looks as if the short seller achieved the goal of sending the price lower from the early July peak. Interestingly the Founder, Chairman and CEO owns 57% of the company. Our concern is making a determination to see if we are being adequately compensated for the risk. Our previous suggestion was the sale of the September 35 put at 1.25. Now we are considering a replacement since this option will expire next Saturday.

Trade Plan

Put Sale or Covered Call Alternative

DR: This is a rapidly growing Chinese company in an attractive business. The high-implied volatility will most likely not last very much longer. It appears there is adequate compensation for the risk. As shown in the graph above the Historical Volatility is 51.91%

SU: On a close below 35 the position should be closed.

Sell FMCN Oct 37 ½ put QOHVU 1.275 IV 75.31 Delta .1946 (sold put = + delta)

Covered Call Alternative

Buy 100 shares of FMCN 44.47
Sell one FMCN Oct 47 ½ call QOHJW 2.750 IV 69.45 Delta -.4335
Debit 4,172 Position net delta +.5665

Ocean Shipping

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

We first introduced Dryships Inc. (DRYS) 70.42, one of the dry bulk carriers in IVolatility Trading Digest™ Volume 7, Issue 15, dated May 21, 2007 when it was trading at 36.15.

The China and India growth story has done a lot for the bulk carriers and they now appear to be making topping patterns. Several including DRYS have easily identified completed Elliott 5th waves.

In the tanker sector the correction that began in early July looks completed and the stocks again appear to be trending higher helped by higher crude oil prices and OPEC’s announcement that they intend to increase production in an effort to help hold crude prices from further rises. This is good news for the tankers, as the increased production means more tanker demand.

Frontline Ltd. (FRO) 45.99. FRO based in Hamilton, Bermuda, engages in the ownership and operation of oil tankers, including oil/bulk/ore (OBO) carriers. As of May 31, 2007 the tanker fleet consisted of 81 vessels. It operates two sizes, very large crude carriers (VLCCs), which are between 200,000 and 320,000 deadweight tons (dwt); and Suezmaxes, vessels between 120,000 and 170,000 dwt. The VLCCs are used for the transportation of crude oil from the Middle East Gulf to the Far East, Northern Europe, the Caribbean, and the Louisiana Offshore Oil Port.

Volatility has been rising during the stock price decline that started in July. Since the low on August 16, 2007 the stock is again rising and appears to be forming a new uptrend. As it rises, both volatility measures should now decline back into the 25-30% range.

Trade Plans

Put Sale

Bull Call Spread

DR: One of the leading tanker companies with one of the largest fleets of modern tankers. Higher OPEC production is the key to higher freight rates as the crude production will need to be transported. The bull call spread has nice edge (IV21.79 bought, IV 26.79 sold).

SU: A close under the last pivot at 38 on August 16, 2007 would be the sign that something is wrong and the trade should be unwound.

Sell FRO Oct 45 put FROVI 2.10 IV 46.80 Delta .4011

Alternative Bull Call Spread

Buy FRO Feb 45 call FROBI 3.075 IV 21.79 Delta .6405
Sell FRO Feb 50 call FROBJ 1.600 IV 26.79 Delta -.3523
Debit 1.475 Position net delta .2882

Calendar Spread

The Calendar Spread Feature on the Home Page for Friday is Washington Mutual (WM) 35.53 in the mortgage finance group, on which we have previously expressed some opinions. While the structure of the suggestion looks good, buying the APR 08 call WMOJ at 4.50 IV 39.01 and selling the Oct 35 call WMJG 2.35 IV 50.40 for a 1.95 debit, remember calendar spreads will get hurt if there is a large move in the stock price. There is considerable uncertainty in the mortgage finance sector and the extent of individual company exposure will not be known until they begin reporting for the third quarter, sometime in late October. This lack of earnings visibility causes considerable uncertainty especially because of the requirements to mark-to-market mortgage holdings and derivatives risk. From a fundamental perspective we suggest this is just a little too risky for a calendar spread.

Noteworthy

General Motors Corporation (GM) 34.22. We first introduced GM in IVolatility Trading Digest™ Volume 7, Issue 21, dated July 2, 2007.

On Thursday GM gapped higher on the news of a possible deal between the automaker and workers over health-care costs. The company and the United Auto Workers are continuing to talk through the weekend in an effort to find a solution and to reach a deal on a new labor contract. Both the stock and option volume numbers were significantly high on Friday. The current Historical Volatility is also high at 52.97 along with put Implied Volatility at 61.22. We would expect both volatility measures to decline after the UAW negotiations are completed.

Consider:

Selling GM OCT 35 put GMVG 2.865 IV 59.73 Delta .5026

Tellabs Inc. (TLAB) 10.09. Our last update on TLAB was in IVolatility Trading Digest™ Volume 7, Issue 28, August 27, 2007. Since then it was reported that Nortel Networks Corp. (NT) 17.09, the Toronto based telecom equipment supplier is considering an offer for TLAB. On Friday the options were active and the IV Index increased 6.71 points to 48.67 as we discovered when reviewing the “Top 5 stocks with greatest IV change from yesterday” on the Home Page. TLAB was the leader in this category with a 16% IV Index Change, giving further support to the takeover thesis. With a Historical Volatility of 42.49 look at this inexpensive bull call spread.

Consider:

Buy TLAB Dec10 call TEQLB .90 IV 37.37 Delta .5879  Sell TLAB Dec 12 ½ call TEQLV .175 IV 37.52 Delta -.1788  Debit .725 Position net delta .4091

Macy’s Inc. (M) 30.18 was also in the “Top 5 stocks with greatest IV change from yesterday” with a 10.01% increase in the IV Index to 53.61. Now that the stock is down at the 30 support level it appears more interesting. With a Historical Volatility of 47.19 here is a bull call spread.

Consider:

Buy M Oct 30 call MJF 2.125 IV 51.83 Delta .5605  Sell M Oct 35 call MJG .675 IV 56.14 Delta -.2356  Debit 1.45 Position net delta .3249

Caterpillar Inc. (CAT) 73.16. CAT is often referred to as one of the best examples of US manufacturing capability and globalization strategy. Earnings expectations for this company are high and when they disappoint the stock sells off sharply as the Implied Volatility rises with the Historical Volatility. We had an example last October and we have just seen another with the most recent July report. The Historical Volatility now 24.66 is again declining along with the Implied Volatility. Here is a put sale suggestion on a quality company that should benefit from a declining US dollar.

Consider:

Sell CAT Oct 70 Put CATVN 1.605 IV 32.76 Delta .3139

Las Vegas Sands Corp. (LVS) 120.69. One of the leading Macau Casino companies appears to be overbought and due for a correction following a 20 point advance on the potential future expansion comments of Chairman Sheldon Adelson along with an upgrade by Harry Curtis at JP Morgan. Adleson said, "I’ve been quoted as saying Asia can handle 10 Las Vegas’s, maybe I’m off a little bit—maybe it’s 8 maybe it’s 12." We say, close them out for now and - we shall return.

Melco PBL Entertainment (Macau) LTD. (MPEL) 15.19. After finding support in early May at the 14 level the stock has subsequently tested this level six times in an effort to break back out to the upside. On Thursday it managed the breakout on JP Morgan’s Harry Curtis’s speculation that they may team up with Harrah's in a deal to manage a future development on the Cotai Strip of Macau. Another consideration could be the Special Purpose Vehicle (SPV) that we mentioned in IVolatility Trading Digest™ Volume 7, Issue 26, dated August 6, 2007. If the funding for the SPV has been completed and it is now buying stock this would also explain the ability of the stock to breakout above 14. After a retest of the 14 area we would expect to see 18 before reporting third quarter earnings.

Beating Our Own Drum

Compagnie Generale de Gophysique-Veritas (CGV) 59.25. In IVolatility Trading Digest™ Volume 7, Issue 26, dated August 6, 2007, we suggested call ratio back spread on this apparently under appreciated Oil Service Company. The Jan 55/50 call ratio backspread had an indicated debit of .85. The combination of a higher stock price and increasing volatility now values this spread valued at 5.10. A 500% gain is a good return on investment in about five weeks. Now the plan is to watch for a topping pattern, such as a key reversal on increased volume, as the exit signal.

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 futures issues. If you have questions or comments just let us know. If you have some trading ideas that you would like to share with us just use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.