Volume 8, Issue 36
The Week That Was
Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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In the early 1960’s David Frost hosted a satirical television comedy program on BBC Television called That Was The Week That Was, also known as TW3. Take a look at the young David Frost on the front cover of this forty-five year old edition of Radio Times. If they were not so serious some of the historical financial market developments last week could qualify as good satirical comedy material.
In an effort to better understand the current risk in the markets we will make a list of the week’s events. While we acknowledge we are not likely to get them all we hope it will include the most significant ones.
Next, deviating from our normal format we will briefly review the SPX and VIX in the Strategy section before offering a few suggestions for next week. We close with a Takeover File Update on a trade that worked out according to the plan along with its follow-up adjustments.
The Week That Was
Without representation as to omissions or accuracy here is this list of things to consider that transpired last week.
Lehman Brothers files a Chapter 11 petition of Bankruptcy.
After reducing their credit lines about a week ago, Bank of America announced it will buy Merrill Lynch.
New York Governor David Paterson allowed AIG to borrow $20 billion from a subsidiary.
The US Senate Committee on Energy and Natural Resources held a hearing and took testimony on the role of speculative investment in energy markets. It included the testimony from a respected veteran oil analyst who said “I Believe the energy markets in recent years have been driven more by speculation than by industry fundamentals of supply and demand.” At the same time he released an equity research update report titled Curbing Oil Speculation. Time for Change, saying, “Government inaction and lack of regulation have contributed to what amounted to the fleecing of America by speculators who created the oil bubble.”
Barclays agreed to buy $2 billion of Lehman’s brokerage and real estate assets.
The US Treasury announced an $85 billion loan package to “bailout” AIG, significantly diluting the existing shareholders.
In a mad rush for safety the 90-day Treasury bills are bid up in price to where they closed on Wednesday with an indicated yield of just .02%, the lowest since 1940.
The NYSE and CBOE said they are now providing “Threshold Securities” lists on their web sites with details on the companies whose stock has been sold short that have not been delivered according to SEC rules, called FTDs (Fail to Delivers).
The US Securities and Exchange Commission (SEC) announced it will now enforce a ban on naked short selling and then extends the ban to include options market makers.
Some California and Texas pension plans were reported to be withdrawing share lending facilities for their long stock holdings to prevent them from being used for short sale purposes.
The Federal Reserve arranged $180 billion of support facilities from other central banks.
Berkshire Hathaway announced its MidAmerican Energy Company will acquire Constellation Energy at $26.50 per share after Standard & Poor’s threatened a downgrade that would have required Constellation to post another $3.3 billion of collateral for its trading and hedging operations.
The CBOE Volatility Index (VIX) traded as high as 42.16, the highest level since October 9, 2002, but then closed down 3.12 at 33.10.
SEC temporarily banned shorting 799 financial companies.
The Treasury said it would extend $50 billion from a fund established in the 1930’s for foreign exchange intervention to be used to insure money market funds.
The Treasury sent a $700 billion financial markets rescue to plan to Congress to remove “toxic” mortgage related debt off the balance sheets of US banks and financial institutions.
New York Attorney General Andrew Cuomo announced he is investigating Morgan Stanley, Goldman Sachs and others to see if short sellers spread false rumors to drive down stock prices.
The regulator of the commodity markets, the US Commodity Futures Trading Commission (CFTC), said it will provide temporary and conditioned hedge position limit exemption relief for firms taking on swap positions from distressed companies, such as Lehman and AIG.
SEC will force hedge fund and investors managing more than $100 million in securities to disclose their daily short sale position.
SEC opened market manipulation investigations that will require brokerages, hedge fund managers and institutional investors to declare their firm’s positions under oath.
Facing an options market halt the SEC reversed its short sale restriction on options market makers.
Restrictions on Chinese industry imposed for the Olympics expired on Saturday September 20, 2008. Will they now hit the restart button?
US Federal restrictions on offshore drilling in the outer continental shelf will expire on September 30, 2008 unless it is extended by Congress.
Strategy
After this week we think the best strategy is to be careful and cautious since the rules have been changed and the markets now contain some unusual and untested risk and uncertainty. For those who seek opportunity in the current confusion we suggest limiting position size as a risk management tool.
S&P 500 Index (SPX) 1255.08. For the week the SPX advanced 3.38 points or .27%, but we all know that is not the whole story. It also went down to 1133.50 on Thursday September 18, 2008 before a key reversal up on almost 759 million SPY (the SPX ETF) shares traded. As a result of the key reversal on unusually high volume in conjunction with the high VIX (see below) we are now ready to declare that unless we receive more adverse negative fundamental news, we have probably seen the bottom for this cycle. This declaration comes with one further condition: the VIX must now decline back down to and remain under 30. Further supporting this view is a now well defined Elliott 5th Wave that appears to be completed.
CBOE Volatility Index (VIX) 32.07. For the week the VIX traded as high as 42.16, one of the highest recent readings. However, it also reversed along with the SPX in a key reversal. We wrote last week that the VIX was poised to attack the 30 level and it did. Now we would like to see it start declining in a normal downward slopping pattern and remain under 30 to help support the view that we have seen the bottom of the equity market for this cycle.
IVOLopps™
Best Calendar Spread
Direct from the “Options Data Analysis” and the “Rankers & Scanners” sections of our front page we offer this “Best Calendar Spread” suggestion for your consideration. We also note that the last time we provided details for the “Best Calendar Spread” was for Lehman Brothers Holdings Inc. (LEH) .13 in our IVolatility Trading Digest™ Volume 8, Issue 33, and aptly named Financial Crisis, dated September 2, 2008. That suggestion is a good reminder about position size limits and the advantages of using a portfolio approach for option positions. Nevertheless here is another suggestion, this time not in the financial sector.
National Oilwell Varco, Inc. (NOV) 60.09. Nov designs and manufactures oil drilling systems, components, and products for the oil and gas industry worldwide. If the offshore drilling restrictions expire at the end of the month it could help turn this sector higher once again. In the meanwhile a calendar spread seems like a good idea. With a current Historical Volatility of 90 and likely to decline with a rising stock price, consider this calendar spread.
- Buy NOV Feb 60 call NOVBL 9.30 IV 57.21 Delta .5907
- Sell NOV Oct 60 call NOVJL 4.70 IV 67.99 Delta .5466
Debit 4.60 Position net delta .0441
Also consider this alternative idea.
- Buy NOV Feb 65 call NOVBM 7.25 IV 56.72 Delta .5046
- Sell NOV Oct 60 call NOVJL 4.70 IV 67.99 Delta .5466
Debit 2.55 Position net delta -.0420.
In addition, look at this put sale with good edge as both Volatility measures decline back to a forecasted level of 50-60.
- Sell NOV Oct 50 put NOVVJ 1.325 IV 77.93
Another Value Idea
As a follow-up to last week’s value suggestion here is another pipeline to consider.
Enterprise Products Partners LP (EPD) 25.91. Enterprise Products Partners L.P. is a midstream energy company, providing services to producers and consumers of natural gas, natural gas liquids, crude oil, and petrochemicals. At the current price it yields 7.9%, selling at 11.7 times forward earnings. They are expanding operations and have operations in the Barnett shale play. Interestingly the Chairman of the Board bought 487,952 shares in the open market between June 4, 2008 and September 5, 2008 at prices ranging from 27.62 to 30.51. The stock has just made a pivot at the 23 level and is turning higher. With a current Historical Volatility of 41 look at this put sale idea.
- Sell EPD Oct 25 put EPDVE .60 IV 35.34 Delta.3335
Long Term Solar
LDK Solar Co.Ltd. (LDK) 41.44. LDK is a manufacturer of multicrystalline solar wafers used to produce solar cells. LDK sells wafers globally to manufacturers of photovoltaic products, including solar cells and solar modules. In addition, LDK Solar provides wafer processing services to monocrystalline and multicrystalline solar cell and module manufacturers. Its headquarters and manufacturing facilities are located in Hi-Tech Industrial Park, Xinyu City, Jiangxi province in the People's Republic of China. They also have an office in Sunnyvale, California. In addition, they have just completed an ADR offering of 4.8 million shares at 41.75. The proceeds will be used for expansion of its polysilicon plant and wafer production with 10% to fund general corporate activities.
Having made a pivot at 35 and now turning higher once again look at this solar idea. The current Historical Volatility is 95 but should now be declining.
- Sell LDK Dec 35 put LDKXG 4.60 IV 99.16 Delta .2736
Then, use part of the proceeds to buy this bull call spread.
- Buy LDK Mar 50 call LDKCJ 6.95 IV 82.21 Delta .4994
- Sell LDK Mar 55 call LDKCK 5.50 IV 80.40 Delta -.4278
Debit 1.45 Position net delta .0716
Buffet Put Sale
Constellation Energy Group, Inc. (CEG) 25.76, supplies energy products and services to wholesale customers, and retail commercial, industrial, and governmental customers in North America operating in three segments: Merchant Energy, Regulated Electric, and Regulated Gas. This is the company that Berkshire Hathaway announced its MidAmerican Energy Company will acquire for $26.50 per share after Standard & Poor’s threatened a downgrade that would have required Constellation to post another $3.3 billion of collateral for its trading and hedging operations. Take a look at these put ideas. The current Historical Volatility is now 162 but will decline rapidly as the stock trades around 26.
- Sell CEG Oct 20 put CEYVD 1.35 IV 128.33 Delta .1872
Or
Sell CEG Oct 22 ½ put CEYVX 2.05 IV 128.33 Delta .2873
While the Oct 20 put is safer it does not have the premium of the 22 ½ and both are priced with the same implied volatility. The risk here is that MidAmerican is unable to complete the deal due to regulatory or other obstacles forcing CEG to meet its margin requirements alone. Following in Buffet’s footsteps we are suggesting this trade based upon the fundamental value of the company and would be acting in a role similar to an insurance company for buyers of the puts who are seeking downside protection.
Takeover File Update
Genentech Inc. (DNA) 92.27. Basel, Switzerland based drug giant Roche Holding Ltd. made an unsolicited and unexpected offer to purchase the remaining 44% of that it does not already own at 89.
DNA called the offer insufficient and is waiting for a higher price. Analysts are indicating something closer to 100 per share is expected. The stock price has just made a pivot at 90 and is turning higher once again. With a Historical Volatility of 20, a wide positive volatility spread with an IV/HV ratio of 2.46 consider this put sale suggestion.
- Sell DNA Oct 90 put DWNVR 3.85 IV 48.76 Delta .3955
In IVolatility Trading Digest™ Volume 8, Issue 34, Too High, dated September 8, 2008 we suggested a long straddle volatility trade for SanDisk Corp. on a takeover possibility by Samsung of South Korea.
SanDisk Corp. (SNDK) 22.52. 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 made their 26 offer or about $5.9 billion on Tuesday and SanDisk quickly rejected it. Analysts now expect Toshiba to make an offer since they already have a substantial stake through their joint venture.
Our original long straddle was priced at 3.68 when the implied volatility readings were 76. Now the price is higher and the implied volatility has risen to 118 and the straddle is priced at 6.725, an 83% gain in two weeks. Because we have an October straddle and we are now facing rapidly declining time value from the long options we need to make some adjustments.
The first adjustment is to convert our long options with declining in time value to a short put that will take advantage of the declining time premium. We close the straddle and then sell an October 20 put.
- Sell to close SNDK Oct 17 ½ call SWQJW 5.90 IV 118
- Sell to close SNDK Oct 17 ½ put SWQVW .825 IV 117
Credit 6.725
- Sell to open SNDK Oct 20 put SWQVD 1.55 IV 111 Delta .2936
Now to we add to the long side with a bull call spread with plenty of time to expiration.
- Buy SNDK Jan 20 call SWQAD 5.025 IV 72.69 Delta .6982
- Sell SNDK Jan 25 call SWQAE 2.49 IV 64.88 Delta -.4739
Debit 2.535 Position net delta .2243
With these adjustments we have increased our net long delta while converting the time decay from negative to positive and extended our time horizon to allow sufficient time for the deal to be completed while taking money off the table. Here are the numbers based upon prices between the bid and offer and before commission costs. The original straddle cost 3.68 and we sell it for 6.725 for a gain of 3.045. Next, we sell the Oct 20 put for a 1.55 credit and buy the January bull call spread for a debit of 2.535. The result is we have taken 2.06 off the table (3.045+1.55-2.535=2.06). We do have assignment risk in the event to stock closes below 20 on the October expiration but this is a risk we understand and are willing to take.
So far this is an example of a trade that is going well and we deserve to beat our own drum.
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.
Posted by Jacqueline Lachance on September 22, 2008 at 08:31 AM EDT
Posted by Jacktrader (68.109.71.202) on September 22, 2008 at 12:01 PM EDT
Posted by petrochemical refinery on October 24, 2008 at 09:22 PM EDT
Website: http://www.petropol.sc/
Posted by Jacktrader (68.109.71.202) on October 25, 2008 at 12:07 AM EDT