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The saga of the dud dollar continues without even a hint that it will try to make a stand. We must be entering the momentum stage of this decline as it is now attracting attention and being reported in the news.

Cheng Siwei, vice chairman of the Standing Committee of the National People's Congress, was quoted by wire services as saying that China should shift more of its $1.43 trillion of currency reserves into "stronger currencies," such as the euro, to offset "weak" currencies like the dollar.

This week we learned, from hip-hop rappers in New York to Indian contract construction workers in Dubai nobody wants to be paid in dollars. The NYBOT futures chart below tells the story.

We first introduced the Dollar Index in Issue 13 on May 5, 2007 as indicated at the arrow above. Since then we have included progress reports of its decline in 15 more recent issues. As we have been saying since early May, stay focused on the dollar.

Market Review

The dollar weakness is affecting the equity markets and we seem to be making topping formations in the major markets that are extending beyond just the US dollar denominated equity markets. London’s FTSE index, denominated in the strong Pound Sterling is off 17% since October 31. 2007. While the markets appear oversold and due for a bounce many indexes are now at or near important support levels and if they fail to hold we could see further declines of 20%-25%. Since options expiration is this Friday, November 16, 2007 we could get the bounce this week that would cause a lot of newly purchased puts to expire worthless. If so, there is a good chance the downside could be tested again starting the week of November 19, 2007.

Strategy

For now the strategy is to look for bear put spreads and put combinations with negative delta. If we do get a bounce this week it will be an opportunity to increase existing positions and find new ones in the weakest sectors. If you are short near the money puts remember the markets will try to punish the most traders and since traders have most likely been buying puts this last week, it would support the bounce scenario through options expiration Friday. As many more people are now realizing the dollar weakness we should expect to see what Harry Schultz says is the most exciting part of the long-term gold bull market, the monetary phase, with the rush to convert dollars into gold.

Special Situation

Before turning our attention to bear put spreads and gold there is one interesting special situation to consider.

China Finance Online Co. Ltd. (JRJC) 32.45, offers subscription based online financial information and data services in China for listed stocks, bonds and mutual funds as well as news research reports, online forums and bulletin boards. With a subscription and advertising model they have been rapidly growing revenues by providing data services for the hot Chinese markets. Currently the stock is just above the 30 support level and they are scheduled to report Q3 earnings on Tuesday November 20, 2007, after November options expiration. Chances are the support level will hold until they report on the 20th. With a Historical Volatility of 110, take a look at these puts.

Sell JRJC Nov 30 put JQJWF 1.675 IV 148.73 Delta .3188

If after reading the research reports you conclude the stock is likely to trade higher on better than expected subscription numbers then also consider this one.

Sell JRJC Dec 30 put JQJXF 4.60 IV 137.37 Delta .3402

Bear Put Spreads

We begin by looking for a short strategy or a hedging strategy for other long holdings that are now at risk if the equity markets fail to hold their current support levels.

iShares Russell 2000 Index (IWM) 76.85 , this ETF makes a good hedging and short tool since it usually rises faster and declines faster than the S&P 500. This is referred to as having a beta of greater than 1. Since we are interested in hedging market risk by getting short this will do the job. By using a spread we are less concerned about the already rising implied volatility, because we will be long one put while short another. The current Historical Volatility is 25.11.

Buy IWM Dec 78 put IOWXZ 3.625 IV 30.41 Delta -.5225
Sell IWM Dec 72 put IOWXT 1.565 IV 35.29 Delta .2615
Debit 2.06 Position net delta -.2610

Again More Golds

Compania de Minas Buenaventura SA (BVN) 60.04. Peru's biggest precious metals producer, has a 43.65 percent stake in Yanacocha, Latin America's biggest gold mine, which is controlled by Newmont Mining Corp. On October 29, 2007 they reported Q3 earnings of .79, (the estimates were .92) and the stock went up 7 points on reports that gold production is increasing in Q4. The options are thinly traded so be careful when placing orders. The Historical Volatility is 39.56.

• Sell BVN Dec 50 put BVNXJ 1.100 IV 59.46 Delta .1563

This option did not trade on Friday. It was bid .90, offered at 1.30. Use a limit order.

Yamana Gold Inc. (AUY) 13.90. First introduced in IVolatility Trading Digest™ Volume 7, Issue 33, dated October 1, 2007, Yamana reported a 48% increase in gold production for Q3 and .20 per share earnings. Initially the stock traded higher but then retreated with the weak market. The current Historical Volatility is 51.79. Consider this longer-term bull call spread.

Buy AUY Apr 12 ½ call AUYDV 2.90 IV 57.13 Delta .6990
Sell AUY APR 15 call AUYDC 1.775 IV 57.07 Delta .5166
Debit 1.125 Position net delta .1824

Silver

Hecla Mining Co. (HL) 11.48. Coeur D’Alene, Idaho based Hecla is primarily a silver producer with some gold and other metals as by-products. When they reported increased earnings and cash flow on Thursday November 8, 2007 the stock broke out above the 10-resistance level. At these price levels for gold and silver it looks like HL may be back in business. With a current Historical Volatility of 55.29 here are two alternatives to consider.

Sell HL Jan 10 put .60 IV 65.51 Delta .2578

Buy HL Mar 10 call 2.50 IV 60.18 Delta .7291
Sell HL Mar 12 ½ call 1.375 IV 1.375 IV 61.41 Delta –.5014
Debit 1.125 Position net delta .2277

If all three legs were initiated the position would be the equivalent to a covered synthetic call. Long the Mar 10 call and short the Jan 10 put is the synthetic long and then the short Mar 12 ½ call makes it a covered synthetic call. The net debit would be .525 with a position net delta of .4855 producing a low cost silver and gold trade using an old established mining company that may become an acquisition target.

Synthetic Natural Gas

San Juan Basin Royalty Trust (SJT) 36.75. With monthly payments about 7% annualized from revenues that are 98 % derived from natural gas SJT is an interesting opportunity. Natural gas prices have a defined seasonal pattern, declining in the fall after peak electricity production for air conditioning and before the increase in heating demand for winter weather. The stock has already risen from the 32 level in mid September anticipating the increase in natural gas prices that are just now increasing.

Options on the royalty trusts are interesting because the implied volatilites are driven low by covered call sellers looking to increase their income. The timing of the seasonal demand for natural gas is imperfect and weather dependent but can be expected to last through December and perhaps even longer. Since royalty trusts pay a high distribution rates they are somewhat protected from market declines limiting the downside risk. One problem that needs to be considered is the thin trading in these issues requiring some order placing skill and patience. With a current Historical Volatility of 23.73 consider this directional synthetic long.

Buy SJT Jan 35 call SJTAG 2.250 IV 18.63 Delta .7545
Sell SJTMG Jan 35 put SJTMG .725 IV 22.45 Delta .3025
Debit 1.525 Position net delta 1.057

The risk and reward relationship with a synthetic long position is unlike a spread. We have unlimited upside opportunity with the long call, but we do have assignment risk from the short put in the event the stock closes below 35 on the Jan options expiration. In this case our long call would expire worthless and we would buy the stock at 35 plus our debit on the original synthetic making our position cost 36.525. We would then be long a stock that pays a 7% dividend and selling inexpensive calls against our long stock

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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