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Joseph Schumpeter's book, Capitalism, Socialism and Democracy, 1942 characterized capitalism with the famous phrase "creative destruction," in which the old ways of doing things are endogenously destroyed and replaced by the new. He said innovation by the entrepreneur led to gales of "creative destruction" as innovations caused old inventories, ideas, technologies, skills, and equipment to become obsolete. The question, was not "how capitalism administers existing structures... [but] how it creates and destroys them." This creative destruction, he believed, caused continuous progress and improved standards of living for everyone. "[What counts is] competition from the new commodity, the new technology, the new source of supply, the new type of organization... competition which... strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives."

Creative destruction describes the state of current world economic affairs. We are witnessing a massive shift in resources. In the US resources are being reallocated from consumption to production while the inverse is occurring in China and other developing economies. The resulting commodity demand is changing the foundations of many economies and companies. This process of capital reallocation creates opportunities for those who seek them.

Market Review

US equities stalled last Thursday as the Dow Jones Industrials and the S&P 500 indexes were trading at in the resistance level set in the middle of last July. It is too soon to conclude they will continue higher or turn lower as there is a possibility of double tops forming. For now caution is the best course to follow.

In the Treasury market the 10-Year Note and the 30-Year Bonds are trading lower creating defined downtrends as interest rates rise. These trends require careful watching and is another reason for caution.

Strategy

Consistent with Schumpeter’s “ creative destruction” seek opportunities in China, Asia, Brazil, Mexico and Latin America. With a now lower dollar in the US the most likely opportunities will be found with companies that export their products and services. Aircraft, technical medical equipment, machinery, agricultural and food products, chemicals, oil services, engineering and construction services are some examples of groups that would benefit. In addition, with the lower dollar we can expect Canadian, Australian and European buyers to be shopping for US based companies.

Takeovers

On the IVolatility.com home page, in the Rankers & Scanners section you will find: Top 5 stocks by implied volatility change. On Friday October 12, 2007 three of the top five were US chemical companies, two of which are interesting.

Dow Chemical Co. (DOW) 46.50. On Friday the company sent an e-mail to investors making reference to its transformational strategy and postponed its November institutional investor meeting, fueling speculation of an acquisition, joint venture or a buyout of the company. The market reaction was immediate with the share price rising 1.71 to 46.50 and the Implied Volatility Index rising 9.11% representing a 35.51% increase. Included in the news release was also a reference to WR Grace & Co. (GRA) 30.65, up 1.82 on 5.8 million shares, about five times its average volume.

Although the news was not specific about the relationship between the two companies the IV Index increased 13.88% or a change of 23.93 % to 71.86 shown in orange on the chart to the left. With a current Historical Volatility of 32.50, shown in blue, there is a positive volatility spread. Also notice that the IV Index was 90% last November. This would suggest there is the potential for the IV Index to rise higher in the near term. Of course, the stock price could also rise with the implied volatility.

Trade Plan

DR: Grace is a leading global supplier of catalysts and other products and services to petroleum refiners and other specialty chemicals. They may be in talks with Dow Chemical.

SU: If the stock declined back below 27 ½ this would be an indication to reevaluate, as there is a lot of support at this level back in the May-June period.

Alternative suggestions to consider:

Short Put

Sell GRA Oct 30 put GRAVF 1.05 IV 76.17 Delta .3994

Call Ratio Backspread (allows for IV to continue rising as it is long more options than short)

Sell GRA Nov 35 call GRAKG 1.325 IV 72.29 Delta -.3268
Buy 2 GRA Nov 40 calls GRAKH .525 each = 1.05 Total IV 73.83 Delta .1561 each = .3122 Total
Credit .275 Position net delta .0146

AK Steel Holding Corp. (AKS) 49.54. The company sells flat-rolled carbon steel products primarily to automotive manufacturers and customers in the appliance, industrial machinery and equipment, and construction markets. Last week we suggested a Nov 37 ½ put sale when the stock was 42.98 and now the stock is almost 50. The increase in price could be related to negotiations between the automobile manufacturers and the UAW union. With a short six-hour strike at Chrysler they had an agreement. It now seems likely that Ford will also reach a quick settlement over the workers health care benefits issue. When all three US auto makers have new contracts and with a lower dollar they will be more competitive. As a major supplier to the automakers AKS is a significant beneficiary.

With a current Historical Volatility of 48.13 consider this put sale.

Sell AKS Nov 42 ½ put AKSWT 1.075 IV 62.37 Delta .1846

‘The Strategist’ scanners

Using the Naked Put Scanner in ‘The Strategist’ scanners (one of our favorite scanning tools) we have found two more interesting put sale candidates.

JA Solar Holdings Co., Ltd. (JASO) 49.25. Ningjin, China based JA Solar designs, manufactures, and sells solar cells primarily in China. The company offers monocrystalline solar cells. It sells its products primarily through sales and marketing personnel to solar module manufacturers, who assemble and integrate its solar cells into modules and systems that convert sunlight into electricity. JA Solar Holdings Co. also sells its products to customers in Germany, Sweden, Spain, South Korea, and the United States.

JASO stock price and implied volatility is again turning higher producing a nice positive volatility spread. Most all of the stocks in the China group have been volatility recently and this one is no exception. It has taken out its previous high and looks to be going higher once again. The IV Index for the calls are 90.38 and the puts are 89.35, shown in orange on the chart to the upper left while the Historical Volatility is currently 69.69 is also shown in blue on the upper left chart.

A check of the 30 day put/call ratio shows a reading at the .3 level. A high put-to-call ratio often signals a market bottom and low number signals a top. If the ratio falls lower than 0.3, this implies a sense of market euphoria, while a ratio over 0.7 is pessimistic.

Trade Plan

DR: JA Solar is a Chinese solar manufacturer benefiting from high oil prices. An industry concern has been polysilicon and a Collins Stewart LLC analyst noted Thursday that the company has secured supply agreements to fulfill all of its wafer needs through 2010. JA Solar says it will increase production form 175 megawatts worth of generating capacity to 425 megawatts of capacity by the end of next year. At 21 cents per watt they claim to be more cost effective than their competitors. This story has all the attributes of creative destruction and growth.

SU: A close under the recent pivot at 37 ½ would be cause for concern and a position adjustment should be considered.

Consider this put that is currently 9 ¼ points below the stock price.

Sell JASO Nov 40 put QJPWH 1.725 IV 92.39 Delta .1898

IVOLalerts^TM

Our next section we call IVOLalerts^TMOmniture Inc. (OMTR) 33.25. OMTR provides online business optimization services.

This stock was included in last week’s digest in a list of suggestions. Since then the IV Index has continued to rise and is now 80.56, as shown in orange on the chart to the left. It could continue higher or the stock, now in a correction could turn higher. Chances are the stock turns higher in the next few days. In that case the IV would most likely turn lower as well. The current Historical Volatility is 54.59.

Trade Plan

DR: This is a rapidly growing company in the online optimization business with accelerating revenue growth with big names on its customer list. Current stock price appears overbought and is now correcting. Wait for the stock to turn higher again before selling the put. Use an indicator such as Stochastic, Relative Strength or MACD to give a buy signal. It could come in just a few days.

SU: A close below would be a cause for concern and would require reevaluation.

Sell OMTR Nov 30 put MOQWF 1.95 IV 85.70 Delta .2971

These numbers will most likely be different when the stock turns higher again. Watch them carefully and adjust the put price using the delta.

Reader Response Request

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. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.

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