Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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In this issue we continue our recent theme of high volatility trading opportunities by taking a look at the New IVX Monitor located in the Options Data Analysis section just below the IVolatility Trading Digest Blog section on our Home page. The Monitor, with last Friday’s data shown above, provides easy access to current readings of intraday implied volatility for US equity and futures markets. There are a total of 26 implied volatility readings with graphs on many important equity indexes and futures all of which can be seen by using the slide bar. In addition to the current Implied Volatility Index it shows the daily change and the high and low readings for the past year.

In the section below we list all of the underlying securities along with our long term estimate of their potential decline. Then we offer some suggestions for a few short options positions in the event the market fails to hold at the current levels. First our market review.

Market Review

S&P 500 Index (SPX) 873.29. At the end of the week the SPX was 57.70 points lower again last week for another 6.2% decline. Our previously identified small double bottom has now been negated by last Thursday’s low at 818.69. It now looks like the best we can expect is a trading range between 819 on the low side to 1000 on the upside and we do not dismiss the possibility that it will take out 818.69 and continue lower.

S&P 500 Index IVX 63. The Implied Volatility Index Mean added 47.02 last week for an increase of 34%. We would expect it to return to the previous October 27th high of 76.67 if the S&P 500 takes out last Thursday’s low at 818.69 and then continues lower.

US Dollar Index (DX) 86.37. Last week we noted the US Dollar Index appeared to be making classical continuation consolidation pattern and last Tuesday it broke out to the upside with a one- day gain of 1.163 points closing at 87.08. We now have a potential double top at 88 that may create some resistance.

TED Spread 2.10. The TED spread shown on Bloomberg rose .09 last week from 2.01the prior week. We think it needs to continue lower returning to the 1.40 - 1.45 range before we begin to see more positive sentiment for the banking sector.

NYSE McClellan Summation Index. Our market breadth indicator stalled last week and then declined once again with a loss of 40.51. Our indicator is now reading -1.174.77 and its return to the downside is not encouraging from a bullish perspective.

Strategy

The failure of the S&P 500 Index to continue above 1000 and its subsequent decline to a new low has changed the sentiment once again. We now think the best we can hope for in the near term is a trading range as we mentioned above. The US Dollar Index and the Japanese yen continue to show strength from the deleveraging of long commodity and emerging market positions. While there is a possibility that there may be some positive developments at the G-20 meeting over the weekend we think it is prudent to add additional short positions in the retail and financial sectors to complement our crude oil bear put spreads.

IVX Monitor

Our IVX is similar to the CBOE VIX for the S&P 500 Index, but the calculations are somewhat different. We use four at- the- money options for each expiration period and then apply a proprietary weighting technique that includes the Delta and Vega of each option. It is then normalized for multiple periods and shown in three tables, one for the calls, a second for the puts and the third for the mean average between the calls and puts. This is our IVX Mean that we often use for our standard measure of implied volatility. In addition to the standard 30 day period the tables also include the implied volatility measures for multiple time periods including 60, 90, 120, 150, and 180 days. In addition, for each period we include a Hi/Low indicator, defined as the current price minus the low divided by the high-low range. Since the result will be between 0 and 1 it provides a quick estimate of the current implied volatility in relation to the extremes. For example, 0 would mean a new low has been reached while 1 means a new high has been reached. Then we provide the high and low data along with the dates of each and also include the implied volatility in relation to the historical volatility for each period. A graph showing the “Historical Volatility and IV Index vs Price” completes the standard page found at the Implied Volatility Index tab on theAdvanced Historical Data page. Additional details about the calculation methods and a comparison to the VIX can be found at this IV Index link.

The table below shows all of the current underlying symbols displayed in the IVX Monitor with their IVX Mean, Long Term Estimate (LT Estimate) and their Ratio Above the Long Term Estimate. The long- term estimate is a simple visual approximation for the future implied volatility based upon the concept of “mean reversion" or the tendency to return to a mean or average value after reaching extremes without an estimate with respect to time. From experience we know that volatility will often remain in a new range after reaching extremes and we are expecting to see higher ranges for the near future. Nevertheless the ratio gives us a guide as to the relative option valuations with respect to their long- term estimates. In the case of the large US equity indexes they are just above two times higher than their long- term estimates as shown below.

By using the IVX Monitor on our Home page you can quickly get the important intraday implied volatility updates and then when you need more specific details you will find them at our Advanced Historical Data page.

IVOLopps ™

More Bear Put Spreads

In this continuing uncertain environment we think it is prudent to add some bear put spreads to our current list.

Sears Holdings Corporation (SHLD) 38.27 is a broad-line retailer in the United States and Canada. The company operates three businesses: Kmart, Sears Domestic, and Sears Canada. Recently we have made several SHLD bear put spread suggestions. Our last was in IVolatility Trading Digest™ Volume 8, Issue 41, Brothers Grimm, dated October 27, 2008 when SHLD was 47.67.

Once again SHLD came to our attention because of its number two position in the IVolatility.com Ranker for “Top 5 stocks based on IV Index Mean vs 30D HV,” a regular feature on our Home page. With an Implied Volatility Index Mean of 142.46 and a current Historical Volatility of 97.71 it has a positive volatility spread with an IVIndex/HV ratio of 1.46.

SHLD has broken the next lower support area at 50 and is again gaining momentum to the downside. The most recent retail sales reports are providing further justification for this short thesis. With a current Historical Volatility of 98 consider this bear put spread idea.

• Buy SHLD Dec 35 put KTQXG 5.35 IV 151.52 Delta -.3341
• Sell SHLD Dec 30 put KTQXF 3.65 IV 167.28 Delta .2329
  Debit 1.70 Position net delta -.1012

The above indicated debit is based upon Friday’s middle closing prices between the bid and ask. The debit on Monday should be 1.68 if the stock price remains unchanged. Use the position net delta shown above to adjust for any price change. For example, if SHLD is trading Monday one point lower then spread should be trading about 1.78, or about .10 higher.

Harley-Davidson, Inc. (HOG) 15.35, is the American motorcycle king and is given credit for being a well managed company that continues to face the challenge of declining discretionary consumer sales.

We last suggested a bear put spread on HOG about a year ago when it was 32.67 higher at 48.02. In the meanwhile the retail environment has deteriorated further. With a current Historical Volatility of 114 consider this suggestion.

• Buy HOG Dec 15 put JOZXC 2.175 IV 124.67 Delta -.3981
• Sell HOG Dec10 put JOZXB .625 IV 156.13 Delta .1307
  Debit 1.55 Position net delta -.2574

The above indicated debit is based upon Friday’s middle closing prices between the bid and ask. The debit on Monday should be 1.52 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .26 for each point change in the stock price.

American Express Company (AXP) 19.99. AXP is a payments and travel company providing charge and credit payment card products, and travel-related services worldwide. AXP converted itself into a bank so as to qualify for TARP funds and the shares have lost a quarter of their value since the Fed approval came through last Monday night, not a particularly good sign. In addition is has the distinction of being number 5 on this week’s “Top 5 stocks based on IV Index Mean vs 30D HV” list.

With a current Historical Volatility of 109 here is another bear put suggestion to consider.

• Buy AXP Dec 20 put AXPXD 3.20 IV 129.07 Delta -.4190
• Sell AXP Dec 15 put AXPXC 1.375 IV 152.80 Delta .2000
  Debit 1.825 Position net delta -.2190

The above indicated debit is based upon Friday’s middle closing prices between the bid and ask. The debit Monday should be 1.81 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .22 for each point change in the stock price.

Capital One Financial Corp. (COF) 31.19. COF provides various financial products and services to consumers and small businesses. While it has access to bank deposits it has substantial credit card and auto loan assets that may become the next financial crisis. With a current Historical Volatility of 119 here is another financial to consider.

• Buy COF Dec 30 put COFXF 4.05 IV 121.90 Delta -.3834
• Sell COF Dec 25 put COFXE 2.275 IV 136.71 Delta .2315
  Debit 1.775 Position net delta -.1519

The above indicated debit is based upon Friday’s middle closing prices between the bid and ask. The debit Monday should be 1.76 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .15 for each point change in the stock price.

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. If you would like to receive the Digest by e-mail let us know at Support@IVolatility.com.

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