Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

Of course, the breakout we explore in this Digest is not of the type depicted above, but rather the one found in the world of technical analysis.  In addition, we will start using twitter for updates between issues so we have added a link on our web site.  First we have some ideas about the upside breakout of the S&P 500 Index then offer two more long suggestions.  As usual, we begin with a review of our market indicators.
Market Review S&P 500 Index (SPX) 987.48. Last week we wrote about the breakout of the SPX above its previous resistance at 950. We called this a “bell ringer”  since it set off the larger Head & Shoulders (H&S) Bottom as it crossed above the neckline and confirmed the long awaited right shoulder of which now appears to have been formed with the July 10th low at 872.81. The neckline drawn from the January 6th high at 943.85 to the June 6th high at 956.23, when extended, goes through the gap created at the opening on Thursday July 23rd confirming the breakout and setting off the H&S pattern. See the dotted line on the chart below. We calculate the minimum upside measuring objective by taking the distance from the low of the Head at 666.79 on March 6, 2009 from the average between the January 6th high of 943.85 and the June 11th high of 956.23, a slightly rising neckline, or 950.04 (950.04 - 666.79) which is 283.25 points. We then add this to the neckline value of 950.04 and the result is the Minimum Measuring Objective of 1233.29. Ideally, we would have preferred a more symmetrical pattern with respect to the location of the right shoulder. We had been looking for a right shoulder in the 800 to 850 area, but it appears we will have to settle for the July 10th low of 872.81 which may reflect the strength of the market. See the chart below. On the chart, we have also indicated two areas of overhead resistance, the first at 1000, labeled R1 and the second at 1100 labeled R2 below. Either of these resistance levels could offer an opportunity for a pullback and a retest of the breakout. In an ideal world, we prefer to see greater volume on the breakout, but it is summer, when volume is typically lighter. While we are expecting a pullback and retest of the breakout, we don’t know when it will come or how much to expect, it could be quick and short if the relative strength continues. Here is a chart illustrating the SPX Head & Shoulders Bottom.
The E-mini S&P 500 futures contract (ESU9) 984.50 traded on the CME, has been trading with reasonable volume, but it is not breakout volume. In addition, while open interest is expanding it is not substantially higher. Perhaps this again, can be attributed to the summer vacation season.   S&P 500 Index Implied Volatility (IVXM). Now turning to the implied volatility measures let’s look and see what additional information they provide. Our Implied Volatility Index Mean was higher 2.14 at 23.19 and the VIX increased by 2.83 to 25.92. The September VIX futures, premium over cash declined from a 23.6% premium to 14.5%, while the October declined from 25.6% to 15.7%. While the risk premium is still highest in October there was a substantial decline last week. The likely interpretation is the market continues higher but high premiums continue to be paid to hedge risk in September, with the maximum premium being paid for October, a month with a dreadful reputation for significant declines. US Dollar Index (DX) 78.35. The dollar declined another .49 or .62% for the week presumably on the GDP news, although the GDP decline was reported at -1% expectations were for - 1.5%. If exchange rates move primarily in response to news that alters expectations about the future economy then the dollar should have gained on the better than expected GDP report, except the previous quarter was revised downward to -6.4% from -5.5%. The weak economy along with technical forces and a desire to reach the previous support at the June 2nd low at 78.33 seem to have been the driving forces. Watch the 78 level as it will most likely be tested this week. A continuing lower dollar will sustain the commodity complex while a reverse up from the 78 support will most likely be detrimental for commodities. iShares Barclays 20+ Year Treasury Bond (TLT) 94.85. Rapidly increasing after the GDP report with the downward revision of last quarter, TLT was up 3.40 or a substantial 3.7% as long-term interest rates declined for the week. NYSE McClellan Summation Index  1115.84. While seeming to confirm the breakout of the SPX we are now seeing the development of a divergence as the major indexes continue higher but our breadth indicator lags indicating a narrowing of breadth. The McClellan Summation topped at 1217.66 on May 8th when the NYSE Composite was 6000.39 and the SPX was 929.23. Now with the NYSE Composite at 6337.46 and the SPX at 987.48 the Summation index is lagging at just 1115.84. This divergence, should it continue or should it increase, could develop into an important negative for the equity markets.
Strategy There are two breakout strategies, either trade the breakout or trade the retracement. Currently trading the breakout has the advantage, but there will be a retracement at some point. Attentive traders can watch for the developing retracement to close longs, but short positions could be hazardous since the retracement could be shallow and quick similar to the feeble right shoulder of the Head & Shoulder Bottom shown in the chart above. One alternative is open some positions now in anticipation of the pull back with a plan to increase their size when it appears the pull back is completed. Low delta “mostly neutral” long call spreads would fit this description. An another alternative is to use far out-of-the-money short puts while waiting for the pullback.    We continue to favor stocks and ETF’s that have broken out with the broad market, and remain wary of those with potential double top formations including our favorite copper indicator, Freeport-McMoRan Copper & Gold Inc. (FCX) 60.30. We perceive there to be less risk by waiting for FCX to breakout rather than entering a position now on the expectation of a breakout. We suggest opening a bull call spread on the breakout and then adding on the reversal of the retracement. Our other leading indicator of economic activity, the Baltic Capesize Index (BCI) 5385 was up another 215 points for the week.
Portfolio Adjustments In IVolatility Trading Digest™ Volume 9, Issue 27, Crude Oil Déjà vu, dated July 13, 2009, we suggested a bull call spread for NetApp, Inc. (NTAP) 22.46 when it was 19.21.  Since this is a September spread and NTAP now looks overextended we suggest closing this one.  Here are the details.
The mid price on Friday was a credit of 1.575 as shown in the “Price” column above.  Adjusting for time decay the estimated price on Monday should be 1.57 as shown above in the “E Price” column.  Use the deltas for each leg to adjust for any change in the stock price or use the net spread delta for spread orders. Portfolio Update USEC Inc. (USU) 3.87 Last Tuesday after being denied a loan Guarantee from the US Department of Energy, the stock gapped 2.57 lower at the opening.  What a difference a day makes.  No wonder the options implied volatility was high.  Such are the perils of selecting the wrong strategy.  From Digest issue 29,  according to our trade plan we unwound the short put leg of the Iron Condor at 1.15, established the day before, as it crossed below the SU (stop/unwind) previously set at 5 when the stock was trading at 6.19.  The realized and mark-to-market loss is 71 that should be reduced to 66 when the remaining out-of-the-money calls and one put expire at the August expiration.
Twitter for Portfolio Update We now have a twitter link on our home page, currently located in the News box on the upper right side, but soon to be relocated to a permanent location.  We will be using twitter for portfolio updates, closing trades and adjustments made during the week between Digest issues, mostly resulting from  stocks and ETFs exceeding the SU (stop/unwind) levels defined in the trade plans.  This will produce a more timely record for those who closely follow particular suggestions while allowing more space in our weekly Digest for new ideas.  In addition, we will be posting changing volatility, active options and other interesting developments to twitter during the week.  We invite you to join many others who are following us on twitter.
IVOLopps™  Using our RT Options Scanner, we ran some end- of-day volume scans and found an interesting opportunity in the pharmaceutical sector with a good quality well established company. Mylan, Inc. (MYL) 13.19.  Mylan, the world’s third-largest generic drug maker is in a media contest with the US Food and Drug Administration over quality control issues at its Morgantown, West Virginia facility.  As a result, the stock declined 1.75 on Monday July 27th closing at 12.10.      Then, on July 30th they reported 32 cents a share, 2 cents better than expected as revenue rose 5.3% to $1.27 billion, as sales revenues were greater than expected.  One analyst said, “Every segment except for North America generics posted sales above our estimates.” With the current Historical Volatility at 51.2 after the decline from the FDA controversy and with an Implied Volatility Mean Index of 51.3, but with 2.7 times as many calls as puts traded, here are two ideas to consider. The first is a put sale.
The mid price for this put sale on Friday was a credit (Cr) of .65 as shown in the “Price” column above.  Adjusting for time decay the estimated price on Monday should be .62 as shown above in the “E Price” column.  Use the delta as shown above to adjust for any change in the stock price. The second is a long call spread.
The mid price for this spread on Friday was a debit (Dr) of .375 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .37 as shown above in the “E Price” column. Use the deltas for each leg to adjust for the change in prices of the underlying or use the net spread delta for spread orders. Set the SU (stop/unwind) below the last pivot at 12. Here is another idea from the end-of-day volume scan - our old unpredictable favorite, in the news  once again. Yahoo! Inc. (YHOO) 14.21. After reporting earnings on July 21st, and then an agreement with Microsoft for a search advertising partnership on July 28th the stock was hammered on the opening Wednesday July 29th. According to numerous news reports, analysts were disappointed Yahoo did not receive a substantial upfront cash payment with the deal. By Friday options buyers were bargain hunting on the assumption the sell off had gone too far. There were 11 strike price series in August and September with call volume in excess of 2,000 contracts with almost twice as many call as puts traded. The largest open interest was in the August 16 call at 60,771, although the final price for the options was just fourteen and one-half cents.   With a current Historical Volatility at 56, and a 10 day Historical Volatility at 72 with the stock price decline, the Implied Volatility Index Mean is 43. The October, the implied volatilities are almost all the same in the 43-44 range. Consider this long Butterfly Call Spread idea.
The mid price for the spread on Friday was a Debit (Dr) of .40 as shown n the “Price” columns above.  Adjusting for time decay the estimated prices on Monday should be about .41 as shown above in the “E Price” columns.  Use the deltas for each leg to adjust for any stock price change or use the net spread delta for spread orders. Note in the table, line two, we are selling 2 Oct 16 calls.  There are two breakeven points for this spread, one lower at around 13 ½, the other higher at 18 ½.  Our plan anticipates it may continue lower in the near term, but will recover by October and ideally close at exactly 16 on the October options expiration.  If so, the maximum gain will be the difference between long and short strikes of 2 points less the initial debit, of .41 or 1.59.  This would produce a very favorable risk to reward ratio, but everything needs to go according to the plan.  While we are willing to accept the risk on the downside, we suggest using 18 as the SU( stop/unwind) on the upside, either to close or adjust.
Bookstore Remember our bookstore for you options reference information and material, in addition to the vast amount of articles and information on our web site.    In the next week’s issue, we will continue our focus on the breakout of the S&P 500 Index and offer some additional ideas to scale up as it rises.  We will also be commenting on the potential double tops found on the charts of some important commodity issues.

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.

IVolatility.com | Account Services | Services & Tools | Forum | Overview | IVolatility Blog | FAQ | Awards | Other Financial Resources | Search

2006 Copyright IVolatility.com All rights reserved. Privacy Statement, Disclaimer, Security