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Dollar Dilemma

It is claimed that because the di- in dilemma comes from a Greek prefix meaning "two," the word should be used only when exactly two choices are involved.

The US economy appears to be decoupling from the rest of the world (RoW) causing a dollar dilemma.

More rate cuts by the Federal Reserve will increase inflation risk and improve conditions for the creation of the next asset bubble along with increasing commodity prices, oil, and gold in conjunction with a declining dollar. On the other hand, without further rate cuts the probability of a US recession increases. The declining dollar is the messenger sending the signals highlighting the equally undesirable alternatives.

The US Dollar Index (DX) 77.72, basis cash, is now at an all time low. DX traded slightly lower during the week but then made a sudden move lower on Friday afternoon. The response from gold and the gold miners was immediate. The Market Vectors Gold Miners ETF (GDX) 45.35, declined to 44 at mid week, but on Friday afternoon quickly reversed upward with the sudden decline in the DX. Watch last Friday’s high of 45.96, as it is now the new resistance level.

Market Review

Implied Volatilities for both the S&P 500 and the NASDAQ 100 are mixed. The S&P 500 IVX Index for the calls increased slightly from 15.80 last week to 16.65, while the puts declined from 17.34 to 15.94, indicating somewhat lower put prices. For the NDX the call IVX Index increased to 19.27 from 16.97 while the puts declined from 18.86 to 18.75. The increases in the call IVX Indexes along with declines in the put IVX Indexes indicates a diminishing interest in buying put protection.

In the Treasury market the 10-Year Note closed to yield 4.58%, down from 4.63% the prior week. The 30-Year Bond closed to yield 4.83%, down from 4.89% last week. Both interest rate measures declined for the week providing support for equities.

The NYSE McClellan Summation Index, our market breadth indicator, now in positive territory, continued rising for the sixth week with a reading of 61.91, an improvement of 122.54.

Strategy

Our strategy suggestion remains as we outlined in IVolatility Trading Digest™ Volume 7, Issue 32, 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

Hong Kong is a unique situation. Because the Hong Kong dollar is pegged at a fixed exchange rate to the US dollar their monetary policy is being determined by the US Federal Reserve. The decline in the Fed Funds rate was followed by a similar decline in the Hong Kong base rate from 6.75% to 6.25%. In Hong Kong the supply and demand for goods and services is a function of economic activity in China, but their monetary policy is being set by US domestic economic conditions. The result is a booming Hong Kong economy with declining interest rates. Remember Macau and the Casinos are a part of the Hong Kong economy.

Suggestions

Yingli Green Energy Holding Co. Ltd. (YGE) 26.07. Through its principal operating subsidiary in China- Baoding Tianwei Yingli New Energy Resources Co., Ltd., Yingli is one of the leading vertically integrated photovoltaic (PV) product manufacturers in China, Based in Baoding, China. Yingli designs markets, manufactures and installs photovoltaic products in the People's Republic of China. In addition, it sells photovoltaic modules to photovoltaic system integrators and distributors located in various markets, including Germany, Spain, China, and the United States.

Since the options have not been trading very long Yingli has an attractive positive volatility spread as indicated in the graph on the left with the orange line representing IV Index Mean of the options and the blue line representing the Historical Volatility of the stock. The stock price is in the lower graph. Because there are not as yet a lot of options being traded you will need to be careful with order entry and the bid/offer spread. Use limit orders and know where your limit should be based upon the stock price using the delta of the position.

Trade Plan

DR: Photovoltaic (PV) manufacturer in a rising energy cost environment. Put/call ratio is under .3. Reported December 2007 estimate of 2.87 and a forward price to earnings ratio of 5. One analyst is projecting 82% growth in 2007 and 90% growth in 2008. The current Historical Volatility is 76.30.

SU: The stop/unwind is 17 ½. Do the fundamental research and know the risk you are assuming with the positions you consider. Selling a put means you could be assigned 100 shares of stock for each put sold. Make sure you can assume this level of risk and that you would be the comfortable owner of the stock. In this event the plan would be to then sell calls against the long stock.

Sell YGE Nov 20 put YGEWD 1.375 IV 109.59 Delta .1916

Takeover Talk

Here is an interesting development that has the signs of a company preparing itself for sale. If you like electronic gadgets do the fundamental research and then consider this one.

EchoStar Communications Corp. (DISH) 46.81. EchoStar provides satellite delivered digital television to customers in the United States. EchoStar bought Sling Media, a company producing Slingbox, a device that allows viewing of recorded TV programs over the Internet. It then says they will split into two companies, one for the DISH network and the other for the remaining pieces of the company including the newly acquired Sling Media. The most interesting part of the story is the report that AT&T might buy them. The numbers mentioned in the Barron’s Online article were $55 bid/$65 offered.

The rising IV Index Mean along with the Historical Volatility would be consistent with recent increased options activity and rising stock price. The current put/call ratio (not shown on the graph) is at the encouraging .3 line with recent increases in the call open interest. If AT&T has been talking to them they could have been instrumental in the recent Sling Media acquisition and the proposed restructuring. If this were the case it seems like they would want the restructuring completed before making a bid for DISH. If so, it could be quite some time before we hear more about this deal.

Trade Plan

DR: Takeover speculation with all the risk that such activity entails. It may not happen or it may take longer than excepted. Slowing consumer product sales is also a risk to consider. Your risk is the debit and the maximum gain is the difference between the strikes less the initial debit. The current Historical Volatility is 39.21.

SU: There is a well-defined stop/unwind point at a close under the 38 level.

Buy DISH Dec 45 call UABLI 4.35 IV 34.49 Delta .6531
Sell DISH Dec 50 call UABLJ 2.10 IV 34.91 Delta -.4073
Debit 2.25 Position net delta .2458

More Gold

In the event the US Dollar continues its rapid decline as we discussed above some additional gold positions would most likely prove to be worthwhile. Do the fundamental research and then consider these suggestions.

Yamana Gold Inc. (AUY) 11.78. Toronto based Yamana is a gold and copper miner with properties in Brazil, Argentina, Honduras, and Nicaragua. It has just agreed a three way deal to combine itself with Meridian Gold (MDG) 33.10 and Northern Orion Resources (NTO) 6.43 creating a mid-tier copper and gold producer that will be producing 1.5 million ounces of gold per year by 2009 and 2.2 million ounces by 2012. Although based in Canada all of its mining operations are in countries with significantly lower labor costs. With a current Historical Volatility of 50.64 consider this call ratio backspread for a credit.

Sell AUY Jan 12 ½ call AUYAV 1.175 IV 53.51 Delta -.5002
Buy 2 AUY Jan 15 calls AUYAC .475 each = .95 total, IV 52.21 Delta .2627 each = .5254
Credit .225 Position net delta .0252

Market Vectors Gold Miners ETF (GDX) 45.35. With a Historical Volatility of 32.73 consider this put sale. The previous resistance at 42 was broken on the move to almost 46. Now the 42 level should provide support on any pull back.

Sell GDX Oct 42 put GDXVP .55 IV 41.45 Delta .2024

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. 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.

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