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Market Review

All of our indicators are agreeing and giving the same signal, that for the short term, the equity markets will most likely continue higher. The volatility indexes are retreating, interest rates have stabilized at lower levels, the US Dollar Index (DX) has turned higher once again, the NYSE McClellan Summation Index has again turned upward and finally the Japanese Yen is pulling back toward the 88 support level. For now we have a green light that may well continue through the end of the year.

Strategy

December is usually a positive month for equities, but remember there is still a lot of negative fundamental news about mortgages and financial market liquidity that yet needs to be digested. China too is looking better, but continue to be alert and watch your positions carefully.

iShare Russell 2000 Index ETF (IWM) 76.58. Last week we suggested the sale of the December 74 put, the IOWXV at 1.9375, with an implied volatility of 32.88. The put has now declined to 1.075 while the implied volatility has declined to 29.79. Since this put makes a good short-term market indicator, carefully watch its price and implied volatility. If the IWM begins to stall and starts to turn downward once again the price and the implied volatility, of this out-of the money December 74 put with just days 16 to expiration will rise again. Since the time value is now declining rapidly pay particular attention to its implied volatility.

Suggestions

While using the IVolatility.com rankers and scanners searching for volatility based trading ideas we often find biotech or biopharmaceutical opportunities that we know are very difficult to evaluate from a fundamental perspective. Most often the high-implied volatility is created by uncertainty related to understanding the myriad of complicated approval levels involved in the FDA process. Indeed this is the case for the company that has been occupying one of the top spots in the high IV/HV ratio ranking for several weeks

Medarex Inc. (MEDX) 12.70. Princeton, New Jersey, based Medarex is a biopharmaceutical company, that is working to commercialize human antibody-based therapeutic products to treat cancer, inflammation, autoimmune disorders, and infectious diseases. The company applies its UltiMAb Human Antibody Development System and clinical manufacturing technologies to generate, support, and commercialize a range of fully human antibody product candidates. Its partners include Amgen, BMS, Centocor, Eli Lilly, Genmab A/S, ImClone Systems, MedImmune, Novartis Pharma AG, Novo Nordisk A/S, Pfizer, and Kirin Brewing Co., Ltd.

There is no specific news that we could find to identify a specific reason for the current high-implied volatility. With a current Historical Volatility of 52.74 here is the volatility chart showing a wide positive volatility spread.

Consider this suggestion:

DR: Large positive volatility spread. Has undetermined fundamentals in a difficult sector to evaluate. Limit size to manage risk.

SU: Unwind the position on a close below 11.

• Sell MEDX Dec 12 ½ put MWMXV 1.35 IV 119.14 Delta .4172

If assigned the stock from the short put at the December expiration then sell calls against the long stock. Basis would be 11.15, the price that has turned the stock higher twice in the last year.

In The News

Citigroup Inc. (C) 33.30. This New York based money center multibank holding company offers banking, lending, insurance, and investment services. They have a network of 8,140 branches and approximately 19,100 automated teller machines in several countries.

The Federal Reserve is sending signals about another interest rate cut while the Treasury Secretary is attempting to structure a national mortgage bail out plan. Now without a Chief Executive Officer and after large mortgage write-offs some think we have seen the bottom for Citigroup. A more likely bottom will be found only after all of the potential losses have been fully exposed after the end of the fourth quarter. In the meanwhile, the stock is bouncing off the 30 level and analysts are declaring that the stock is now at a bargain basement price. The stock has been oversold since the middle of October and the volatility numbers are now at a high Type II pattern around 50. We would expect both volatility measures to decline back to the 20%-30% range in 4-6 months assuming their structured investment vehicle lending issues are resolved. In the meanwhile, look at this put sale.

DR: Oversold financial that is due for a bounce on better news. This may not be the final bottom.

SU: Buy the put back on a close below 30. It could go lower.

• Sell C Jan 30 put CMF 1.15 IV 54.43 Delta .2576

Motorola Inc. (MOT) 15.97. Motorola provides wireless and broadband communication products through three business segments: Mobile Devices, Home and Networks Mobility, and Enterprise Mobility Solutions. After a long struggle corporate raider Carl Icahn seems to have the upped hand in an effort to change management and reorganize MOT and he has succeeded in forcing the resignation of Ed Zander the current Chief Executive. Icahn said, “In my opinion, Motorola should be split into separate companies: a mobile devices company; and enterprise mobility company; a connected home company and a company focused on mobile networks infrastructure…” With a Historical Volatility of 33.37 there is no volatility edge. For this reorganization opportunity consider this bull call spread.

DR: This stock has been oversold since mid October and is due for a bounce. It may take some time for a restructuring to be defined. A longer-term position makes this time allowance. This is a low cost entry into this situation. If the developments continue to be favorable the position can be added and/or adjusted

SU: A close below 15 would be the sign that something is wrong and the position should be reevaluated and perhaps closed.

• Buy MOT Apr 15 call MOTDC 1.965 IV 34.47 Delta .6774
• Sell MOT Apr 18 call MOTDS .625 IV 32.10 Delta-.3315
  Debit 1.34 Position net delta .3459

With a defined maximum risk of the debit the gain is limited to 3.00 less the debit, or 1.66.

Dry Bulk Shippers

With the markets turning higher the dry bulk shippers are rebounding once again. We often find stocks to buy when they are in the news and overbought making the purchase too risky. Then when they pull back we loose confidence and do not make the purchase. Here is a way to enter this sector where the fundamentals remain very strong.

DryShips, Inc. (DRYS) 98.48. DryShips is the owner of a fleet of 35 dry bulk carriers comprising 5 Capesize, 27 Panamax, 1 Handymax, and 2 newbuilding Panamax vessels with a combined deadweight tonnage of approximately 3 million, carrying dry bulk commodities, including coal, iron ore, and grains, bauxite, phosphate, fertilizers, and steel products. DRYS charters its ships in riskier and more profitable the spot cargo market. With a Historical Volatility of 128.47 and with a current Type II high volatility pattern consider this put sale.

DR: Stock is rebounding after sell off. The industry fundamentals remain strong. Volatility levels should return to the 60 level in 3-4 months as prices rise again. Previous support is at the 80 level.

SU: Unwind the position with a close below the last pivot at 70.

• Sell DRYS Dec 80 put DQRXP 2.90 IV 97.20 Delta .2034

More Shorts

In the last few issues we have mentioned increasing short positions without giving many examples. Here are some bear put spreads that we think are worthy of consideration for the troubled consumer sector.

Sears Holdings Corporation (SHLD) 105.51, is a broad-line retailer in the United States and Canada. The company operates three businesses: Kmart, Sears Domestic, and Sears Canada.

Here is an extract from a report on their latest earnings release.

Sears Holdings Corp. Chairman Edward Lampert criticized media coverage of his company and Wall Street commentary in a letter to employees Friday, a day after the retailer said its profit plummeted 99 percent in the third quarter.

The chairman said Sears, like other retailers, has struggled with a difficult overall economic environment. Lampert noted that much of Sears' merchandise is related to home improvement, home maintenance and home turnover, which are tied to the struggling housing market.

Lampert also said that Wall Street and the media have held Sears to a tougher standard than other retailers, including Home Depot Inc., Lowe's Cos., Macy's Inc., Kohl's Corp. and J.C. Penney Co.

"When other companies manage expenses carefully, it is often characterized as a sign of good management and prudence," Lampert said. "In the case of Sears Holdings, meanwhile, expense controls are often cited as a root cause of poor performance."

It seems like a stretch to think that SHLD who is operating in the same market segment with well managed Home Depot (HD), Lowes (LOW) and J.C.Penny (JCP) could be selling at anywhere near the same forward price earning multiple. Here they are from Yahoo finance:

SHLD 12.76
HD 11.61
Low 13.12
JCP 9.06

With a Historical Volatility of 50.79 consider this bear put spread.

DR: This is a poorly managed company in tough a competitive market segment undergoing declining sales resulting from the deteriorating housing environment. If the well managed companies are having trouble in this economic environment there is not much hope for one that has lost its brand value.

SU: A close above 120 would be a signal to unwind the position.

• Buy SHLD Mar 100 put KTQOT 7.85 IV 48.63 Delta -.3533
• Sell SHLD Mar 90 put KTQOR 4.55 IV 51.27 Delta .2273
  Debit 3.30 Position net delta -.1260

Harley-Davidson, Inc. (HOG) 48.02, is the American motorcycle king and is given credit for being a well managed company that now faces the challenge of declining discretionary consumer sales. While the Asian and European business appears to be improving it still represents just 20% of total sales.

Last month, Harley-Davidson reported its third-quarter profit fell 15.3 percent amid a continued sluggish U.S. market for motorcycles. The company said it expects next year also to be difficult, as domestic buyers become more cautious about spending given rising oil prices and slumping home sale prices.

The company cut shipments and earnings expectations in September. Shipments were down 10.8 percent to 86,535 units in the most recent three-month period. They expect full-year shipments to be between 328,000 and 332,000 units, down from 349,196 units last year.

Then on Wednesday November 28, 2007 Standard & Poor's Ratings Services Lowered the Investment-Grade Ratings on Harley-Davidson citing lower sales and profits because of a challenging retail motorcycle environment.

S&P said consumers have been cutting spending on nonessential items in recent months because of concerns about the housing downturn and eroding credit.

Credit analyst Hal Diamond said in a statement that the downgrade also reflected reduced liquidity resulting from buybacks and dividend increases surpassing discretionary cash flow.

If they have been using discretionary cash flow to buy back stock is seems likely the stock will now face further pressure as they can no longer support its price.

With a Historical Volatility of 32.08 consider this bear put spread.

DR: Declining sales in a weak retail motorcycle environment.

SU: Unwind the position on a close above 50.

• Buy HOG Feb 47 ½ put HOGNW 2.75 IV 35.14 Delta -.4380
• Sell HOG Feb 42 ½ put HOGNV 1.20 IV 39.67 Delta .2191
  Debit 1.55 Position net delta -.2189

Jarden Corp. (JAH) 26.36. Jarden is a collection of niche branded consumer products used in and around the home. For some time now Jarden has been under attack by Jim Chanos, a leading hedge fund short seller, for its accounting treatment of its many acquisitions. With a weak consumer environment the accounting criticism seems to be attracting more attention as the stock has declined from 45 in July. With a Type II high volatility pattern and with the current Historical Volatility at 52.54 consider this bear put spread.

DR: This company faces two serious issues, declining consumer sales and accounting criticism from a credible short seller.

SU: A close back above 30 would be a sign that the position should be unwound.

• Buy JAH Apr 25 put JAHPE 2.475 IV 52.19 Delta -.3565
• Sell JAH Apr 20 put JAHPD .875 IV 56.07 Delta .1549
  Debit 1.60 Position net delta -.2016

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. Send us your questions or comments, or if you would like for us to take a look at a specific stock or ETF just let us know. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.