Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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The big event on the calendar this week is the G-20 Summit being held on London on April 2. It is sure to be the focus of the financial media. Will this G-20 be like many others resulting in a carefully worded statement but little subsequent action? How could such a big problem be solved at a one-day meeting? Perhaps it will lay the foundation for a new global reserve currency that addresses the fundamental economic imbalances between the developed and emerging economies.

A difficult challenge indeed, but we think this G-20 Summit may be different, reminding us what Winston Churchill once said.

“A pessimist sees the difficulty in every opportunity;
an optimist sees the opportunity in every difficulty.”

In the meanwhile, we continue looking for options opportunities based on volatility using the tools of technical analysis and trade planning. In this Digest, we open with a high volatility favorite and then update two previous ideas, followed by two more Takeover File suggestions. First, our brief market review.

Market Review S&P 500 Index (SPX) 815.94. Just when the SPX looked about ready to retreat, it continued higher last week rising another 47.29 points or 6.2%. We were a little hasty with our opinion that a correction had begun, but we still see the market and many sectors as overbought and the expected pullback will now come from a somewhat higher level. The gain from the March 6, 2009 low at 666.79 to last Thursday’s high at 832.98 is 166.19. Applying our .618 Fibonacci retracement ratio, would indicate a new lower limit of 730. This means if the expected pullback holds above 730 and then turns higher we will likely see the development of a new 1-2 Elliott up-wave. On the other hand, if it continues below 730 then chances are it will retest the low at 666.79 forming a double bottom or it could continue even lower. We think holding 730 is even more likely than it was last week at 720 and the new 1-2 up-wave is the process of being formed. S&P 500 Index Implied Volatility. The Implied Volatility Index Mean (IVXM) declined 3.21 points to 37.84 and our IVX Monitor, using intra-day data declined 3.10 to 37. For the IVXM there is now a fairly well defined range with 38 as the low to 50 at the top. The corresponding VIX range is 40 to 52. Watch the volatility measures as SPX pulls back and retests the 730 level. If they spike above their recent ranges then this would be an indication of doubt about the 730 level holding. US Dollar Index (DX) 85.14. DX declined 2.09 for the week after creating what appears to be a pennant continuation formation, but then broke out to the upside on Friday. We attribute this unusual move to nervous currency uncertainty ahead of the G-20 Summit meeting. Some participants are expressing concern that the US is attempting to inflate away the value of the huge US Treasury debt they are holding. The discussions about this issue and the need for more quantative easing will keep the currency markets on edge. We think the DX is headed lower and Friday’s move was an aberration since a pennant as a reversal formation is very rare. iShares Barclays 20+ Year Treasury Bond (TLT) 104.56. This ETF attempts to duplicate the price and yield performance of the long-term sector of the United States Treasury market as defined by the Barclays 20+ Year U.S. Treasury index. Now trading in a range from just above 100 to 105, we think TLT makes a good indicator for long-term inflation expectations. A breakdown below this range would signal the return of inflation concerns and higher long-term interest rates. NYSE McClellan Summation Index. Our breadth indicator continued higher with another gain of 377.94 points as the index rose up to -176.12 as gainers once again exceeded decliners on the New York Stock Exchange.

Strategy

As we previously suggested we think many companies and sectors are now overbought and will pullback over the next few weeks. This would be consistent with the SPX forming a new Elliott Wave 1-2 pattern that would set the stage for an eventual return to higher equity values. Some materials and energy stock appear to be lifting up above their previous trading ranges. There is a chance they could be forming new uptrends so they should be watched carefully as the SPX pulls back as we are expecting. Stay focused on the groups with the relative strength such as crude oil, but be careful with natural gas as there is clear divergence between these two energy sources.

IVOLopps™

Volatility Leader Straddle

Dendreon Corp. (DNDN) 4.42. Seattle based Dendreon, a biotechnology company engaged in cancer treatment, is expected to release data sometime in April on their prostate cancer treatment Provenge. It seems like DNDN is always at the top of our IV Index/HV Ratio table. This week the ratio was 2.39 with the Implied Volatility Index Mean at 239.04 and the Historical Volatility at 99. In the past two weeks the stock price has almost doubled rising from 2 ½ and the options volume has increased substantially. Perhaps all the good news is already in the stock price.

The high-implied volatility gives us an indication of the potential movement in the stock price and we are expecting the news to be released sometime in April. We suggest consider using a volatility trade as the excess implied volatility will come out of the options with the news release. One volatility strategy is the sale of a straddle, but for this event, we want to add a long call for some protection on the upside as very favorable news could drive the stock considerably higher. We start with the straddle.

Sell DNDN May 5 call UKOEA 2.09 IV 241.29 Delta -.6216 (2.04) Sell DNDN May 5 put UKOQA 2.775 IV 241.29 Delta .3784 (2.73) Credit 4.865 Position net delta -.2432

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about 4.77 (see each leg price above) if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .24 for each point change in the stock price. If the stock price is lower, adjust the expected credit higher. If the stock price is higher, adjust the expected credit lower.

Here is the extra long call for more upside protection.

Buy DNDN May 15 call UKOEC .715 IV 213.58 Delta .1253 ( .69)

The debit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the debit Monday should be about .69 (see above) if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .13 for each point change in the stock price.

The credit for the combination is 4.08 with a position net delta of -.1179

The downside is well protected by the net credit and the upside is protected to about 9 ½. Since we would be unprotected on a price rise above 9 ½ we suggest limiting the numbers sold as further risk management.

Gold Update

In IVolatility Trading Digest™ Volume 9, Issue 4, Refinery Time, dated January 26, 2009 we suggested a call ratio backspread in Yamana Gold, Inc. (AUY) 9.22 when it was 7.72. The trade plan suggestion set the SU (stop/unwind) at no change in stock price for 15 days or a decline in implied volatility below 80. By the middle of February to implied volatility declined below 80 so, following the plan this trade would have been closed for a loss of .298 or $29.80 for a 1 x 2 position.

Electric Update

Constellation Energy Group, Inc. (CEG) 20.62

IVolatility Trading Digest™ Volume 8, Issue 47, Bad News, dated December 8, 2008, we suggested a covered call when the stock was 27.58. Previously we had sold puts and calls reducing the stock basis to 21.805. Since this stock is one that we think vulnerable to a correction, we suggest the sale of another call against the long stock. With a current Historical Volatility of 65, consider this call sale.

Sell CGE Apr 20 call CEYDD 1.875 IV 77.63 Delta -.6015

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about 1.77 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .60 for each point change in the stock price. If the stock price is lower, adjust the expected credit lower. If the stock price is higher, adjust the expected credit higher.

Takeover File – Double Deal

Terra Industries Inc. (TRA) 29.14.

In IVolatility Trading Digest™ Volume 9, Issue 3, Political Picks, January 19, 2009 we suggested the sale of a March 17 ½ and a March 15 put. Both expired when the stock closed at 26.60 on March 20, 2009. Total credit after commissions were 2.53 based on one lot sizes.

Since CF Industries Holdings Inc. (CF) 73.30 is still attempting to buy TRA another put sale is in order. With a current Historical Volatility of 72 consider this additional put sale.

Sell TRA May 25 put 1.425 IV 77.16 Delta .2472

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about 1.34 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .25 for each point change in the stock price. If the stock price is lower, adjust the expected credit higher. If the stock price is higher, adjust the expected credit lower.

In the event the stock closes below 25 at the May options expiration be prepared to take the stock by assignment and then sell calls.

The interesting part of this story is CF Industries Holdings Inc. (CF) 73.30 is being bid for by Calgary based Agrium Inc. (AGU) 38.34. Could this become a three-way Pac Man combination? The AGU bid has increased the price of CF from 64 to 73. This takeover bid and the TRA one above are both being contested, so implied volatilities are likely to remain high. If one is good then two is better. Consider this CF put sale with a current Historical Volatility of 75.

Sell CF May 60 put 1.625 IV 62.30 Delta .1627

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about 1.50 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .16 for each point change in the stock price. If the stock price is lower, adjust the expected credit higher. If the stock price is higher, adjust the expected credit lower.

Use a close below 65 as the SU (stop/unwind).

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.