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Although the Oil and Gas sectors appear overbought the lack of any near term help from policy makers in the US or Saudi Arabia means that it will be some time before the dynamics of the markets will change. Since we had been anticipating a correction in the oil sector we now think it is better to go with the flow and get on the right side of this sector. We continue to be on the right side of the broader equity market.

We are going to expand our strategy review and update some of the previous suggestions for both the markets and the oil sector. Then we will take another look at BUD and a repair strategy for HUN.

Market Review

S&P 500 Index (SPX) 1278.38. The SPX and all of the equity indexes accelerated to the downside last week. We expected the SPX to decline to the downside-measuring objective at 1300 from the complex Head & Shoulders Top created by the May 19, 2008 high of 1440.24. Now there are three alternatives to consider. First, this decline could be a part of a larger Head & Shoulders bottoming pattern. The second alternative is a double bottom formed on the decline to 1256.98 on March 17,2008. Or third, it could continue lower. Since it now appears oversold look for a short-term bounce.

The CBOE Volatility Index ( VIX) 23.44. The VIX continued higher and appears to be in a defined uptrend. If we were near a bottom in the SPX we would expect to see the VIX up in the 30 range. This lack of enthusiasm in the VIX seems to be suggesting we can expect a lower SPX and a higher VIX near the final bottom of this leg.

The US Dollar Index (DX) 72.36. The DX made no attempt to turn higher this week and now appears that it will return to test the 72 level once again. This weakness was quickly reflected in the lower equity markets, and higher crude oil prices.

NYSE McClellan Summation Index. Our market breadth indicator accelerated to the downside with a decline of 326.29 points ending the week, at –521.00. This is the largest decline since July 27, 2007 and clearly reflects the current market weakness.

Strategy

Last week’s Saudi Oil Summit had little impact on the markets, perhaps expectations were set too high but in final analysis the markets were unimpressed. If the summit marked the beginning of a long-term process then we must wait for further developments as the Saudi announcement of a modest increase in production was given little credit. In the meanwhile it looks as if the best strategy is to go with the flow.

We now suggest closing the bull call spread on UltraShort Oil & Gas ProShares (DUG) 27.57 and the put spread United States Oil (USO) 113.75.

Although we think there could be a short term bounce in the SPX from the current oversold condition we would keep the UltraShort S&P500 ProShares (SDS) 67.02 bull call spreads that we suggested in IVolatility Trading Digest™ Volume 8, Issue 21, Crude Oil Bubble, dated May 26, 2008 and IVolatility Trading Digest™ Volume 8, Issue 23, Hybrid Shorts, dated June 9, 2008. Both of these are September spreads and are doing very well as the market declines.

In IVolatility Trading Digest™ Volume 8, Issue 23, Hybrid Shorts, dated June 9, 2008 we also suggested a July bull call spread for UltraShort Financials ProShares (SKF) 150.73. The SKF has risen from 122 with the decline in the financial sector and the value of the spread has increased from the initial debit of .75 to 3.90, a 312% gain in 3 weeks with a defined and limited risk. Since we are now expecting an oversold rally in the equity market we suggest booking this gain and establishing a new October bull call spread for this sector.

With a current Historical Volatility of 54.80 and an Implied Volatility Index of 85.50 consider this replacement bull call spread for SKF.

• Buy SKF Oct 155 call SKFJS 22.80 IV 72.72 Delta .5602
• Sell SKF Oct 160 call SKFJW 21.15 IV 73.49 Delta -.5304
  Debit 1.65 Position net delta .0298.

The maximum value of the spread is 5 points and with a cost of 1.65 it has a potential reward of 2 times the defined and limited risk. In addition, it has enough time for the market and sector to rally from the current oversold condition before turning lower once again.

SU: Use 130 as the stop and/or unwind.

Go with the flow

Although the oil and gas sector is overbought by most conventional standards we see nothing on the horizon that it likely to change the dynamics in the near term. As we suggested in the Strategy section above we would close the put spread on United States Oil (USO) and replace it with a bull call spread that has a limited and defined risk.

United States Oil (USO)113.75. This ETF seeks to reflect the performance of the spot price of West Texas Intermediate (WTI) light, sweet crude oil. The fund invests in futures contracts for WTI light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels that are traded on exchanges. It may also invest in other oil interests such as cash-settled options on oil futures contracts, forward contracts for oil, and OTC transactions that are based on the price of oil. With a current Historical Volatility of 42.81 consider this bull call spread suggestion for a continuing rise in the price of USO.

• Buy USO Oct 115 call IYSJK 10.50 IV 42.28 Delta .5432
• Sell USO Oct 120 call QSOJP 8.70 IV 43.29 Delta -.4737
  Debit 1.80 Position net delta .0695

The maximum value of the spread is 5 points and with a cost of 1.80 the maximum gain would be 3.20, a reasonable return for a position with defined and limited risk.

SU: Set a stop/unwind at a close under 105.

One more BUD

Anheuser-Busch Companies Inc. (BUD) 62.26. From St Louis, BUD makes and distributes beer in the United States and internationally. The domestic beers are Budweiser, Michelob, Busch, and Natural brand names.

In IVolatility Trading Digest™ Volume 8, Issue 24, Takeover Update, dated June 16, 2008 we adjusted the original calendar spread that resulted in a new Long Dec 55/Jul 55 calendar spread. When adjusted the spread was priced with a debit of 1.10 and has since gained in value to an indicated price of 2.00.

With a current 10-day Historical Volatility of 16.18 and a 30-day Historical Volatility of 33.37 consider this additional put sale to compliment the long calendar spread.

DR: Although BUD does not want to be acquired it looks as if it is just a matter of time. If they could devise an effective defense that probability would most likely now be reflected in a rising implied volatility. Since the IV is declining it supports the view that this deal is likely to be completed.

SU: If the stock closes under 60 we suggest closing the position.

• Sell BUD Jul 60 put BUDSL .85 IV 29.79 Delta .2875

While the IV of the 60 put at 29.79 is less than the 30-day Historical Volatility it is a good bit higher than the 10-day Historical Volatility and better reflects the current volatility expectation as it does not include the price change from the gap when the takeover offer was made. This position is 2.26 points out-of-the money with 19 days to expiration and it appears likely that the deal will be completed at the bid price of 65 or more.

Takeover Blowup

Huntsman Corp. (HUN) 10.69. Salt Lake City based HUN manufactures and markets specialty chemical products worldwide.

In IVolatility Trading Digest™ Volume 8, Issue 22, Contango, dated June 2, 2008 we made three suggestions for Huntsman Corp. (HUN) then trading at 21.93 as it was expecting to complete the a takeover from Apollo Management to combine with their Hexion Specialty Chemicals Inc. On June 19, 2008 the stock declined 8 point on the news that Hexion was suing to terminate the agreement citing the proposed capital structure was no longer viable due to Huntsman’s increased debt and lower than expected earnings. Interestingly, on June 4, 2008 Peter Huntsman filed a Form 4 with the SEC on the purchase of 20,000 shares of stock at between 21.09 and 21.16.

The long November 25/short July 25 call calendar spread was priced at .80 and is now about .10. We suggest closing this position and booking the loss.

The two suggested put sales are both in-the-money and will be assigned on expiration. We do not suggest closing these positions and booking the losses. Since the Implied Volatilites have risen from the 70-80 range to 99.79 we think the better strategy is to receive the stock by assignment and then implement the put recovery plan by selling a covered straddle against the long stock to take advantage of the high implied volatilites. We will return with specific suggestions after the July options expire.

Summer Schedule

We will be taking some time off to relocate our operations and perhaps spend some time at the beach. The next issue of the IVolatility Trading Digest™ will be available on July 21, 2008.

Previous Issues and Reader Response Request

All 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.

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