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On September 18, 2007 Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve and the Federal Open Market Committee delivered the goods - a cut in Fed Funds rate. They surprised the financial markets by delivering a more than expected 50 basis points reduction. Now we wait to see how the markets will react. The initial indications from equities were positive but the 30-Year Treasury bond declined along with the dollar. Are the long bonds and the dollar signaling the start of a trend toward higher long-term interest rates and a continuing dollar decline? It is to soon to tell but it must be considered a possibility. If so, this would give further support to commodity prices, energy prices, and international equities.

Market Review

Market Implied Volatilities for both the S&P 500 and the NASDAQ 100 immediately dropped below their upward sloping trend lines in a clear reversal of trend. For the S&P 500 the calls IV Index declined from 22.67 the prior week to 15.80. The S&P 500 puts declined from 22.72 to 17.34. For the NDX the IV Index for the calls declined from 23.90 to 16.97 and the puts from 23.83 to 18.86. For both indexes the puts have not, as yet declined as much as the calls.

The US Dollar Index (DX) 78.60, basis cash, is now approaching the 1992 all time low of 78.33. For the near term the most likely path is lower. PowerShares DB US Dollar Index Bearish Fund (UDN) 27.20 can be used as US dollar hedge as it rises with the dollar decline.

With the equity market rally on the Fed action last Tuesday the NYSE Advance/Decline ratio scored an impressive 8.7 times more advancers over decliners. For the remainder of the week the ratio was less impressive. Nevertheless, the final tally for the week showed 1.3 times more issues advancing then declining. The McClellan Summation Index improved 186.34 points, now reading a still negative –60.63, but with a well-defined uptrend underway improving the equity outlook.

Strategy

The strategy remains about the same as we suggested last week. From a portfolio perspective review positions to see that we have both long and shorts. China, Oil and Oil Service, Ocean Shipping, Infrastructure, Agriculture, Agriculture Machinery, Industrial Machinery and selected Casinos stocks with Macau operations are among the long suggestions. On the short side the Homebuilders, Mortgage companies and selected retail are the areas to consider. Further, with the lower dollar we can expect Canadian, Australian and European buyers to be active acquirers of US companies.

With the continued dollar decline we did see gold moving higher. The Market Vectors Gold Miners ETF (GDX) 45.48, rose 7.8% from 42.17 last week along with a 2.4% rise the previous week. From a chart perspective it has broken out above the July high of 43.30. We will be watching this sector closely to see if the rally continues. The Federal Reserve has few good choices available to support the dollar, but the central banks could renew gold sale programs.

Takeover Rumors

Cree Inc. (CREE) 32.15. This company develops and manufactures semiconductor materials and devices primarily based on silicon carbide, gallium nitride, and related compounds. The company produces light emitting diodes (LEDs), and high-power products. The LEDs are used in various applications, including backlighting for mobile products, automotive interior lighting, electronic displays, gaming equipment, consumer products, and other electronic equipment. Rumors have General Electric (GE) or somebody else as the buyer. General Electric reportedly denied any interest in buying the company.

This is what the volatility and price charts says.

Both volatility measures have been rising along with the stock price. When and if a takeover or buyout is announced they can be expected to decline. If the rumors prove to be false and there is no bid made the volatility will still most likely decline but at a slower pace. The sale of a near term October 30 put would benefit from the high volatility and the stock has support at the 30 price level. Since Implied Volatility has not yet turned lower there is a chance it can still be going higher.

Trade Plan:

Put sale

DR: Takeover rumor. Risk appears reasonable.

SU: A close under 25 would be the level where we would unwind the position.

Sell CREE Oct 30 put CQRVF 1.45 IV 69.28 Delta .3192

Noble Corp. (NE) 50.74. Noble provides contract drilling services for the oil and gas industry with a fleet of 63 offshore drilling rigs, 13 semisubmersibles, 3 drillships, 44 jackups, and 3 submersibles. The rumors have SeaDrill from Norway working on a three-way deal with Noble and two other offshore drilling companies. Last Thursday Noble’s Chairman and CEO resigned giving a good indication that something is developing.

The volatility measures are both high and are likely to be declining. Even when rumored deals come true they often take much longer to develop and be announced than the options market expects. The near term October 47 ½ put could be used in combination with a longer-term bull call spread. Do some research on the offshore drilling sector and then consider this suggestion.

Trade Plan:

Combination of put sale and bull call spread.

DR: Takeover and consolidation in the offshore drilling sector. If the takeover does not occur business conditions are still good and the company will continue operating.

SU: A close below 45 would change the outlook for this position and would require unwinding.

Sell NE Oct 47 ½ put NEVW .90 IV 39.92 Delta .2499

Buy NE Dec 50 call NELJ 4.60 IV 38.79 Delta .5934
Sell NE Dec 55 call NELK 2.425 IV 37.70 Delta -.3950
Spread debit 2.175 Position net delta .1984

Mining Companies

The combination of the equity market recovery and the cut in the Federal Funds rate produced a double bonus for the mining companies. Many have already broken out above their previous July highs.

Teck Cominco Ltd. (TCK) 48.02. Vancouver based Teck Cominco produces zinc, copper, and metallurgical coal, as well as precious metals, lead, molybdenum, electrical power, fertilizers, and various specialty metals. It also owns an interest in oil sands leases, and has a partnership interest in an oil sands development project. It is rapidly approaching, but has not yet exceeded its July 13, 2207 high of 50.89.

With a Historical Volatility of 43.86 consider this bull call spread:

Buy TCK Feb 50 call TCKBJ 3.80 IV 36.53 Delta .4983
Sell TCK Feb 55 call TCKBK 2.050 IV 35.24 Delta -.3288
Debit 1.75 Position net delta .1695

Freeport-McMoRan Copper & Gold Inc. (FCX) 108.67. Freeport-McMoRan, engages in the exploration, mining, and production of copper, gold, and silver. It holds interests in the Grasberg open pit and the Deep Ore Zone mines in Indonesia. The company also owns interests in the Grasberg block cave, Kucing Liar, Deep Mill Level Zone, Ertsberg Stockwork Zone, Mill Level Zone, Big Gossan, Dom open pit, and Dom block cave. In addition, it smelts and refines copper concentrates, and markets refined copper products.

With a Historical Volatility at 54.51 and likely to decline consider this put sale:

Sell FCX Oct 95 put FCXVS 1.425 IV 52.03 Delta .1592

Companhia Vale do Rio Doce (RIO) 30.45. Rio de Janeiro based RIO operates as a diversified metals and mining company worldwide. It produces and exports iron ores and pellets to the steel industry, as well as manganese ores, iron alloys, and metallurgical ore. They also produce nickel, copper, platinum-group metals, such as platinum, palladium, rhodium, ruthenium, and iridium; precious metals, including gold and silver; coal; and other non-ferrous minerals. In addition, their operations include bauxite mining, alumina refining, and aluminum metal smelting operations.

With a Historical Volatility on the high side at 65.28 and expected to decline consider this put sale:

Sell RIO Oct 27 ½ put .60 IV 51.21 Delta .2217

Barrick Gold Corp. (ABX) 40.06. Toronto based ABX products include gold, copper, silver, and zinc. The company holds interests in various gold mineral resources in the US, Australia and South America.

With a Historical Volatility of 47.19 consider this bull call spread with 7 ½ points between the strike prices and a good 4.5 risk to reward ratio.

Buy ABX Jan 42 ½ call ABXAV 2.40 IV 34.83 Delta . 4482
Sell ABX Jan 50 call ABXAJ .75 IV 36.06 Delta -.1830
Debit 1.65 Position net delta .2652

Reader Response Request

Once 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. We welcome your suggestions. If you have questions or comments just let us know. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.