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“Too high” is the first song in Stevie Wonder’s Innervisions album released by Tamla/Motown on August 3, 1973. Innervisions won Grammy Awards for Album of the Year and Best Engineered Non-Classical Recording in 1974. The picturesque album cover is shown above.

Our “too high”reference is to the US Dollar and perhaps a better expression is “too high too fast”. We are not sure this what Stevie had in mind, nevertheless it is fitting since the US Dollar has risen 10.87% in the past seven weeks. We provide more details below in the Market Review section along with observations and comments on the S&P 500 Index.

Then we offer a volatility suggestion for the top ranked stock with the greatest positive volatility spread from our regular featured “Top 5” found in the Rankers & Scanners section of our front page. We continue our emphasis on volatility with another interesting put sale idea in the biotech sector and then finish with a new addition to the takeover file.

Market Review

S&P 500 Index (SPX) 1242.31. For several weeks we have been writing about the expected retest of the July 15, 2008 low at 1200.44. Last Thursday and Friday may have been the retest we have been waiting for. It had many of the requirements including a key reversal on Friday with typical short covering behavior. Does this mean we now have a defined double bottom in place? We are not so sure for a few reasons including the lack of enthusiasm shown by the VIX index and the yet to be completed Elliott 5^th wave. In addition, the trading volume of the SPY, the ETF for the SPX, was just 58% of the July 15, 2008 volume at only 289 million shares compared to 502 million at the July bottom. While a double bottom is a real possibility we are hesitant to declare this is the final bottom just yet.

CBOE Volatility Index (VIX) 23.06. The VIX closed Friday at 23.06 but the high for the day was only 24.71. This does not seem comparable to an intra-day high of more than 35 on the March SPX decline or the intra-day high in excess of 30 on the July 15^th low. The Friday high at 24.71 was just the 5^th day of increase from the August 28, 2008 low at 19.22 and was just a 5.49 point or 29% rise. If we compare it to the rise from May 19, 2008 at 15.82 to the peak on July 16, 2008 at 30.83 that rise was 99%. Therefore, we conclude that the VIX is not yet confirming that we have seen the final low in the SPX.

US Dollar Index (DX) 78.93. After consolidating and making a continuation pattern between 76 and 77 the DX broke out above 77 ½, traded as high as 79.077 on Thursday and then closed Friday at 78.932. For a currency with many trillions outstanding we think a 10.87% move in seven weeks is “too high too fast” and we should now expect a correction back to 76 or perhaps even 75. The apparent overhead resistance is at the 80 level where it made a pivot at 80.39 before turning higher on December 27, 2004 and then again when it traded between 80 and 81 for six weeks during the summer of last year. While exchange rates move primarily in response to news that alters expectations about the future economic environment and the relationships between economies, this rapid move has the look of short covering. We now suggest unwinding or at least hedging long US Dollar or short Euro positions.

NYSE McClellan Summation Index. Our market breadth indicator advanced a bit higher last week adding 79.45 and closing at -195.56. This continually improving indicator is making a positive divergence since it is a long way from confirming either a double bottom or an Elliott 5^th wave bottom in the SPX. Interestingly, the NYSE Composite Index (NYA) 8033.76 is now lower than it was on July 15, 2008 and would qualify as an Elliott 5^th wave bottom. The divergence between the McClellan Summation Index and the NYSE Composite is considered bullish adding weight to the double bottom argument for the SPX.

IVOLopps™

Number One

In number one place at the “Top 5 stocks based on IV Index Mean vs 30D HV”, one of our favorite ranking tools we have Dendreon Corp. (DNDN) 5.66, a company engaged in the discovery, development, and commercialization of novel therapeutics that harness the immune system to fight cancer. The products include active cellular immunotherapy, monoclonal antibodies, and small molecules products to treat cancer. They are expecting to see interim data next month from tests of Provenge, an active cellular immunotherapy for prostate cancer and this is the likely driver for the high and rising options implied volatility. After rising up from 4.25 the stock is now rolling over amid skepticism about next month’s data. With an Implied Volatility Index Mean of 168.16 and a current Historical Volatility of 35.71 the IV/HV ratio is 4.71 creating a large positive volatility spread. Since we think implied volatility could rise even more before the interim results are announced consider this put ratio backspread suggestion.

• Buy 2 DNDN Oct 5 puts UKOVA 1.81 (2 x .905 each) IV 168.78 Delta -.6112 (2 X -.3056)
• Sell DNDN Oct 7 ½ put UKOVU 2.745 IV 191.16 Delta .5393
  Credit .935 Position net delta -.0719

Since we are expecting the stock to move downward and the implied volatility to rise we are long more put options than we are short to gain the advantage of the expected increase in implied volatility. Since we have time decay risk with the extra long put we want the stock to decline fairly rapidly. The price risk is the difference between the strike prices less the net credit, or 1.56.

Biotech Again

Elan Corp. Plc. (ELN) 12.96. After loosing almost two-thirds of its value in July on negative phase II trial news and news on of a regulatory filing of two new cases of a serious and often deadly brain infection in multiple sclerosis patients being treated with Tysabri the stock has stabilized and looks to be slowly moving higher on analysts recommendations. After the large stock price decline the volatility numbers are still high but are declining back toward their normal ranges. The near term 10 day Historical Volatility is 44.46 and since the recent daily trading ranges are very small we expect it to continue declining. In the meanwhile the options implied volatility while declining, remains fairly high in what we call Type II Volatility. Here is a suggestion for the continuing decline of both volatility measures.

• Sell ELN Oct 12 ½ put ELNVV 1.225 IV 84.03 Delta .3905

If the stock closes below 12 ½ on the October put option expiration then take in the stock by assignment and sell calls against the long stock as the implied volatility is likely to remain relatively high for awhile.

Takeover File

SanDisk Corp. (SNDK) 17.64. Milpitas, California based SNDK designs and markets NAND-based flash storage card products that are used in various consumer electronics products. In addition, they have substantial joint venture manufacturing operations with Toshiba.

Samsung of South Korea has announced they are considering making a bid for the company. Samsung, who is one of SNDK’s largest customers, is attempting to take advantage of SNDK’s current lower stock price hoping to realize a substantial component cost savings by owing their supplier. Analysts are divided on the prospect of a successful bid pointing out the change of control provisions in both their joint venture with Toshiba and their large 1% Convertible Note due 2013. As yet we do not know how the company will respond to this trail offer that has been floated by Samsung. However we do see the news has caused both the call and put volume to rise substantially along with the options implied volatility. With the level of complexity and uncertainty surrounding this proposed deal we think there is a good chance that implied volatility will continue rising.

On Friday the stock traded almost 55 million shares and closed up 4.18. The current Historical Volatility is 99.86 and rising along with the options Implied Volatility Index Mean of 81.61 that is also now rising.

Consider this long straddle suggestion as a volatility position.

Trade Plan

DR: Rising options implied volatility position with an upside bias. The plan also includes the provision that if there is rapid stock price rise sell the call and keep the put for any likely retracement.

SU: We suggest setting a stop/unwind at the September options expiration date. If the implied volatility is not rising and the takeover has not been defined by then the position should be unwound by selling both options.

• Buy SNDK Oct 17 ½ call SWQJW 1.94 IV 76.89 Delta .5690
• Buy SNDK Oct 17 ½ put SWQVW 1.74 IV 76.40 Delta -.4323
  Debit 3.68 Position net delta .1367

The position has a positive delta bias but the objective is for both of the options to increase in relative value from increasing implied volatility. Each leg has limited risk defined by the premium but with unlimited upside potential. The biggest concern is the time decay of both long options. If the takeover activity is postponed or delayed we can loose time premium. Since the time decay accelerates in the last month we do not want to hold this position for more than two weeks. We think there is a reasonable chance for the stock to make a move to the upside as this proposal could seen as an opportunity for industry consolidation in a market that has been under margin pressure due to excess capacity. However, since the stock has declined from 32 in May we estimate that Samsung would have to offer more than 20 per share in order to get the cooperation of the SNDK management and shareholders.

We do not anticipate making any adjustments by buying or selling stock as this is not a delta neutral volatility strategy since it has a long bias as we are expecting a higher offer price to be developed.

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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