Volume 8, Issue 11
Ben's Magic Show
Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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In an impressive display of creativity Ben Bernanke and the Federal Reserve pulled not one but two rabbits out of the hat last week. The first was the creation of the new Term Securities Lending Facility (TSFL) announced last Tuesday and the second was its almost immediate application in a rarely used rescue plan for Bear Stearns Cos. JP Morgan Chase will facilitate Bear’s access to the Fed.’s discount window so they may obtain 28 day funding backed by illiquid mortgage securities. The Federal Reserve has now established a pattern of announcing good news, which is shortly followed by negative news. We should now be watching for the next two-act hat trick and be wary of the next good news announcement.
The announced Term Securities Lending Facility of as much as $200 billion will be available against Mortgage Backed Securities as collateral. For a market that has grown to over $6 trillion this is just 3.3%. We wonder if this will this be enough or if it could be just the first tranche of many more to come?
Is this the mechanism that will ultimately re-liquefy the capital markets or is it a symptom of just how bad the situation has become?
Market Review
The equity markets rallied on the first Federal Reserve announcement and then gave back a good portion on the second. For the week the S&P 500 Index (SPX) 1288.14 lost 5.23 points. We are still projecting the SPX will decline to the Head & Shoulders Top minimum measuring objective at 1225.
The CBOE Volatility Index (VIX) 31.16 closed up 3.67.
The US Dollar Index (DX) 71.66 continued lower without pausing as it crossed below 72.
The NYSE McClellan Summation Index declined 259.88 points to – 477.46.
Strategy
Keep the shorts in the consumer discretionary sector and consider adding shorts in the financial sector once again. Consider additions in the inflation sensitive commodity sector, agriculture, mining, oil and oil service sectors.
IVOLopps™ Financial Short
When we last visited Fannie Mae in IVolatility Trading Digest™ Volume 7, Issue 25, Fakeout Breakout, dated July 30, 2007 it was trading at 59.39. At that time we suggested a long Dec 60 put and a short Dec 55 put with a 2.00 debit. Since FNM closed at 36.99 on December 21, 2007 we maximized the spread potential more than doubling our initial investment in less than 6 months.
In light of the recent developments in the mortgage and residential real estate markets we are returning to FNM once again.
Fannie Mae (FNM) 22.36. Fannie Mae provides funds to mortgage lenders through the purchase of mortgages, issues and guarantees mortgage-related securities and securitizes single-family mortgage loans into Fannie Mae mortgage-backed securities (MBS). The mortgage problem is directly related to declining house prices and we expect house prices will continue declining until they return to levels that are affordable based upon average income. For several years these ratios were completely out of line as easy lending standards drove house prices higher and higher – they are now returning. Based upon this FNM has the potential to go to zero as all of its capital will be absorbed by declining mortgage values.
Trade Plan
DR: The mortgage backed security problem is far from being resolved and further capital impairments at FNM are likely. If FNM is nationalized there will be nothing left for the shareholders.
SU: On a close above 30 we would unwind this position.
With a current Historical Volatility of 83.74 consider this bear put spread.
- Buy FNM Sep 25 put NJWUE 7.150 IV 83.68 Delta -.4678
- Sell FNM Sep 17 ½ put NJWUW 3.50 IV 99.01 Delta .2507
Debit 3.65 Position net delta -.2171
This is a defined and limited risk position with good edge and the potential to double in six months with a continuing decline in the value of FNM shares.
VIX Update
In IVolatility Trading Digest™ Volume 8, Issue 10, Ides of March, dated March 10, 2008 we suggested a VIX bull call spread, long Apr 25 call and short the Apr 35 call with an indicated debit of 2.575. The VIX closed at 31.16 while the current indicated price for the spread is 3.425, for a 33% one-week gain of .85.
Now with the 10-day Historical Volatility at 115.17 we are adding one more bull call spread suggestion along with the same caution.
Trade Plan
DR: Again this trade is being suggested as the S&P 500 Index appears to be nearing the previous low where it may attempt to reverse direction or continue lower. The expectation is the implied volatility of the index options will increase as it accelerates to the downside. It could reach the 35 objective and then quickly return to 25. The plan is to sell the spread on an intraday basis when it trades above 35.
SU: Sell or unwind this spread if the VIX fails to trade above 30 as the market declines or it if spikes to 35 and you miss the closing trade.
- Buy VIX Apr 30 call VIXDF 2.125 IV 38.85 Delta .6572
- Sell VIX Apr 35 call VIXDI .975 IV 60.67 Delta -.2974
Debit 1.15 Position net delta .3598
With a good edge this spread requires management and needs to be watched daily. It will most likely require closing on an intraday basis as the VIX spikes above 35.
Yellow Gold
With the Fed scrambling to re-liquefy the financial markets we continue to see considerable interest in the options of the gold miners. With Comex gold (cash) closing at 1002.66 consider adding another bull call spread in Yamana Gold Inc. (AUY) 19.39 as it breaks out above 19.
With the current Historical Volatility at 54.76 consider this suggestion:
- Buy AUY Jul 15 call AUYGC 5.15 IV 55.36 Delta .8351
- Sell AUY Jul 25 call AUYGE .90 IV 54.72 Delta -.2738
Debit 4.25 Position net delta .5613
DR: This is defined and limited risk direction trade without edge.
SU: On a close below 17 unwind the spread.
Shining Silver
As the gold market continues higher it begins to attract the attention of silver and in late January 2008 silver broke out above the 16 level to where it is now trading at 20.67 on the Comex basis cash. Having just completed a consolidation pattern at the 20 level it looks as if it is about to break out to the upside once again.
Silver Wheaton Corp. (SLW) 19.38. Vancouver, BC based Silver Wheaton Corp.engages in the silver production. It purchases silver from Luismin mines in Mexico and the Zinkgruvan mine in Sweden, as well as from the Yauliyacu Mine in Peru. It is the largest public mining company with 100% of its operating revenue from silver production. Silver Wheaton's 2008 silver sales are expected to approximate 15 million ounces, increasing to 25 million ounces in 2010. Silver Wheaton is unhedged and well positioned for further growth. Goldcorp (GG) has just completed the sale of their 48% interest in SLW thereby greatly increasing the share float. With a current Historical Volatility of 45.73 consider this put sale suggestion.
Trade Plan
DR: The lower dollar and inflationary expectations are beneficial to silver producers. Silver is breaking out above $20 per ounce. SLW is breaking out above 19.
SU: Unwind the position on a close below 17 or be prepared to buy the stock.
- Sell SLW Jun 17 ½ put SLWRW 1.425 IV 60.04 Delta .3082
With good edge be prepared to buy the stock if it closes below 17 ½ on expiration.
Agriculture
Potash Corp. of Saskatchewan, Inc. (POT) 160.46. Potash Corporation of Saskatchewan, Inc. (PotashCorp) engages in the production and sale of fertilizers, and related industrial and feed products in North America. Increasing worldwide demand for agriculture is driving up fertilizer prices with limited available supply sources. By fundamental measures this stock is not a bargain, yet it continues to rise.
Using a bull call spread provides a reasonable way to participate in this stock which has been a well-defined uptrend since March 30, 2007 when it was 53.31. Now at 160 the trend does not yet appear to have ended. Since we will be buying the difference in two strike prices we are able to limit the amount of the required investment along with the risk while still participating if the stock rises further.
With a current Historical Volatility of 48.59 consider this bull call spread.
Trade Plan
DR: Increasing demand with limited available supply is driving prices higher. POT has access to low-cost phosphate rock and is benefiting from the higher product prices. The stock continues in a well-defined uptrend.
SU: Unwind the spread on a close below 140.
- Buy POT Jun 160 call PYPFL 20.40 IV 59.35 Delta .5738
- Sell POT Jun 170 call PYPFN 16.00 IV 58.43 Delta -.4939
Debit 4.40 Position net delta .0799
With a defined and limited risk this trade is directional counting on the continuation of the uptrend with no volatility edge.
Previous Issues and Reader Response Request
Previous issues of the Digest can be found by using the small calendar at the top right of the first page of any Digest Issue. Click on any underlined date to see the selected issue. 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 future 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.
Posted by tony mangrum on March 17, 2008 at 08:36 AM EDT
Posted by Jacktrader (66.182.123.195) on March 17, 2008 at 03:49 PM EDT
Posted by dhaggstrom on March 18, 2008 at 05:24 PM EDT
Posted by Jacktrader (66.182.123.195) on March 19, 2008 at 12:28 AM EDT