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Track Record the Coolest Kind of Crazy introduces this week’s Digest. After numerous requests for a track record of our suggestions, we have now completed a portfolio accounting from the start of the year. The details are below in the Track Record section. We then offer another hedging suggestion; provide the details of last Thursday’s “Best Calendar Spread” selection and have a new entry for the Takeover File. First, our market review.
Market Review S&P 500 Index (SPX) 896.42. At the end of the shortened trading week, the SPX had declined 22.48 points or -2.45 % on the lightest volume of the year. What looked like a developing Elliott 4th wave to be followed by a higher 5th wave is now in doubt as all the major indexes turned lower after a disappointing US employment report on Thursday. Now instead of an Elliott 4th wave we may be seeing the development of a small Head & Shoulders Top that would take SPX back down below the 850 level. As dreary as this may sound it could be the start of a retest of the March low that many have been expecting. If so, once it completes the retest, it will then form a potential larger Head & Shoulder bottom that we have been watching for several months. Previously we estimated the minimum upside measuring objective of the larger Head & Shoulders Bottom to be up at 1,234. This would be encouraging for the bulls so a retest now may not be as dreary as it seems. For now, the momentum is with the bears. S&P 500 Index Implied Volatility (IVXM). After making new lows for the year, the options implied volatility measures turned higher as the VIX futures had been suggesting last week. The VIX closed at 27.95 up 2.02 while our Implied Volatility Index Mean closed was up 1.86 to close at 25.21. The October VIX futures contract closed with at 10.9% premium over the cash price, compared to the prior week with a 17.8% premium. This still indicates the expectation of a higher VIX in the near term. We previously closed out our bull call spread, but we will be looking to reestablish a new one with closes above its 20-day moving average. US Dollar Index (DX) 80.57. Dollar strength at the end of the week was attributed to safe haven support from declining equities. For the week, it gained .69 remaining above its active downward sloping trendline. A higher DX will put pressure on commodity prices and upon crude oil in particular. The now clear inverse relationship with the equity markets creates an opportunity to use the dollar ETF for hedging equity risk and we offer one idea below.   iShares Barclays 20+ Year Treasury Bond (TLT) 94.30. After two weeks of increasing prices, TLT is following a new upward sloping trendline higher. This appears to be consistent with the stronger dollar and weaker equity prices. NYSE McClellan Summation Index 612.93. Our breadth indicator was just .24 higher for the week, one of the smallest changes recently recorded as the advancers and decliners on the NYSE were almost equal. This equilibrium is unlikely to last very long and may be attributable to the low volume.
Strategy We had been seeing many stocks and groups that looked as if they were completing Elliott 4th waves and turning higher once again. That seems to have at least temporarily come to a halt as we are again seeing many stocks and indexes breaking down. This makes us cautious for the near term while renewing thoughts of more hedging activity and positions with less long delta risk.
Track Record We received many requests for a track record, so we have compiled a record for all the trade suggestions made for the first six months of the year. Since we provided an outline of our model portfolio accounting methodology in IVolatility Trading Digest™ Volume 9, Issue 17, Time for Spring Cleaning, dated May 4, 2009 we will not repeat those details here, but will use the space for more new suggestions instead. At June 30, 2009, our record of closed and open positions marked- to- market, after commissions, was a net gain of $8,010.03. During the six months, we had an average initial margin requirement of $19,349 with an April high of $27,104 and a low of $12,402 at June 30, 2009. Based upon this the return on investment was 41% using the average margin requirement. A more realistic comparison would be to use an initial cash investment of $30,000 to have sufficient margin for the maximum margin requirement of $27,104 in April. Based upon this the return on investment is still a respectable 26.7%. On a risk-adjusted basis, the return is even more attractive considering that most positions, with few exceptions, have limited and defined levels of price risk. For those who normally prefer to trade 5 and 10 lot options positions and 1,000 shares of stock then an initial cash investment of about $250,000 should be about right since there are additional efficiencies available such as relaxed margin rules and lower unit commission costs.
IVOLopps™ US Dollar Equity Hedge As the equity market recovered from the March low, the US Dollar declined. Commentary from the FX market attributes this to the “safe haven” role that the dollar assumed. The dollar declines as risk appetite improves and the dollar strengthens when risk appetites turn cautious as equities decline. The low dollar interest rate has been cited as one cause as the interest rate spread relationship between the major currencies has changed. Another is diversification into foreign assets that reverses when equities decline. While this inverse relationship continues, it offers a low cost opportunity to use the US Dollar ETF as an equity hedge. PowerShares DB US Dollar Index Bullish (UUP) 23.91. This ETF seeks to replicate the price and yield performance of the Deutsche Bank Long US Dollar Futures index. The index is comprised of long US Dollar futures contracts against the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc. Between March 3rd and March 9th UUP made a high of 26.83 and then declined as equities turned higher. With a current Historical Volatility of 14 the put Implied Volatilities are 13 while the calls are 12.60. Using a low cost bull call spread with positive vega we will be able to focus on the inverse equity relationship. The position will also benefit from rising implied volatility that we are expecting. At the March highs, the implied volatility of the UUP options was in excess of 20.
The mid price for this spread on Thursday was a debit (Dr) of .60 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about the same as the time decay is offset by the spread and is shown above in the “E Price” column. Use the deltas for each leg to adjust for any change of price in the underlying or use the net spread delta for spread orders. We suggest using a close below June 2, 2009 low of 23.43 as the SU (stop/unwind). As shown in the table above this a low cost spread with a debit of .60, there is a slight implied volatility edge, positive delta, gamma and vega with low negative time decay, or theta, resulting in an affordable “safe haven” equity hedge. Best Calendar Spread Direct from the “Options Data Analysis” and the “Rankers & Scanners” sections of our home page we offer for your consideration this “Best Calendar Spread” based upon a differential between the implied volatility of the near term call compared to the implied volatility of the deferred month call. M&T Bank Corp. (MTB) 52.40. Buffalo, NY based MTB is the holding company for M&T Bank operating in the Northeastern US. Last Thursday on a day when most of the major bank stocks were lower, MTB was up 1.24 at 52.40. Since they are scheduled to report earnings on July 14, 2009, the rise in the stock price and the option implied volatility suggests the activity is probably earnings report related. We also see put buying has increased over the last two weeks as the put open interest has expanded and exceeds the call open interest by about 10K contracts while the current put/call ratio is a moderately bearish 1.0. With a current Historical Volatility of 46, the Implied Volatility Index Mean is 56. It appears that put options are being used as a price hedge going into the earnings report. Here are the details of the Best Calendar Spread using Thursday’s mid closing prices for the options.
The mid price for this spread on Thursday was a debit (Dr) of 1.90 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about 2.02 as shown above in the “E Price” column. Use the deltas for each leg to adjust for any change in the price of the underlying or use the net spread delta for spread orders. Use a close below the most recent pivot at 45 as the SU (stop/unwind). With a negative options bias from the puts a position with negative delta of around 9 as shown in the table above is about right. The spread reaches its maximum value if the July call expires when the stock is exactly at 50. The stock has been in a 45-60 range since mid April and a return to 50 after the earnings report, assuming there are no surprises looks about right. On a close above 50 at the July expiration, just three days after the earnings report, we will have to buy stock on the Friday before expiration in order to avoid being short and assuming price risk, or buying back the short call and paying the spread between the bid and the offer. Takeover File In the “Rankers and Scanner” section of our home we feature the “Top 5 stocks by implied volatility change” Click on the link and you are taken to the Advanced Ranker Sample of the top and bottom 5 stock in four categories. We often look here for ideas, especially the top 5 stocks based on IV Index Mean vs 30D HV and the top 5 stocks with greatest IV change from yesterday as well as the top 5 stocks within IV Index Mean Range. Last Thursday we found Emulux at the top of all three categories. Emulex Corp. (ELX) 9.46. Costa Mesa, California based ELX is the subject of a tender offer at $11 per share from Broadcom Corp. (BRCM) 25.12, based in nearby Irvine, California. Both companies are in the networking market for moving data and communications between computers, servers, mainframes and storage systems. Emulex dominates the fiber channel while the larger Broadcom dominates Ethernet. The emergence of Fiber Channel over Ethernet, called FCoE, is apparently, what Broadcom wants to obtain by acquiring Emulex. Emulux wants no part of this plan and has been struggling to remain independent since the first offer at $9, was announced on April 21, 2009. BRCM increased and extended the tender offer to $11 with an expiration date of July 14, 2009, three days before the July options expire. In recent days, ELX has sold back down toward the original offer price, which could be put options related as the put open interest has expanded from 20K to 45K pushing up the implied volatility. The put/call ratio at 1.5 reflects this recent put buying activity. However, we note the call open interest still exceeds put open interest by more than two times. While some analysts express the view that a deal is still possible at a price slightly higher than $11 per share price the recent put buying activity along with BRCM’s statements that they are willing to seek other alternatives suggests that a deal remains uncertain. With a current Historical Volatility of 47.56 and with an Implied Volatility Mean Index of 94.67 here is a two part suggestion that will attempt to capture the high put implied volatility by using a partially covered July short put and a long August straddle combination. The position risk profile resembles a call backspread or long straddle somewhat like a lopsided “U.”
Sell Short 50 shares of ELX at 9.46
The prices shown above are based upon the Thursday close. For the option, it was a credit of 1.175 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about 1.07 as shown in the “E Price” column. Use the delta to adjust for any stock price change. Now here is the second part of the position.
The mid price for this straddle on Thursday was a debit (Dr) of 2.175 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about 2.10 as shown above in the “E Price” column. Use the deltas for each leg to adjust for any stock price change or use the net straddle delta for a combination order. The net cash cost is a credit of 370 with an estimated margin requirement of 743. Combining the deltas of the short stock at -50 with the short put of 55.20, and the straddle of -4.95 results in a net delta of .25. The gamma is -18.50 and 30.63 for a net of 12.13. For theta it is 2.66 and -2.04 for a net of .62. The vega is -.78 and 2.82 for a net of 2.04. The result is a position that should benefit if the stock declines back to 7 in the event BRCM withdraws their offer or rises above to 12 or more in the event they reach a deal. In addition with long vega, it should do well if the implied volatility continues to rise.

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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