Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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With the major equity indexes breaking out above their resistance, is now the time to load the boat once again as portrayed by the super tanker shown above?  We explore some considerations and make suggestions along with some risk evaluations.  We offer suggestions for a Calendar Spread, a Bull Call Spread and a table loaded with short put sale ideas.  As usual, we start with a brief market review.
Market Review S&P 500 Index (SPX) 1010.48.  SPX continued higher last week breeching the 1,000 mark and closing up 23 points or another 2.3%.  Last week in IVolatility Trading Digest™ Volume 9, Issue 30, Breakouts & Twitter, dated August 3, 2009 we made the case for the upside minimum measuring objective at 1233.29 and this is the basis of our current strategy.  E-mini S&P 500 Future (ESU9) 1006.50.  As we noted last week this heavily traded futures contract did not have unusually high volume when it broke out above the previous resistance at 950, but the open interest is expanding which is a requirement for a sustainable uptrend.  Perhaps this is all the volume we can expect to see for an August breakout. S&P 500 Index Implied Volatility (IVXM).  All of our volatility measures, except one, declined last week.  Our Implied Volatility Index Mean was lower by .52 at 22.67 while the VIX declined 1.16 to 24.76.  The September VIX futures, premium over cash declined from a 14.6% premium to 13.3%, but the October increased from 15.7% to 17.3%.  While the risk premium is still highest in October there was a substantial decline last week.  The highest premiums over cash continue to be paid for the October futures contract. US Dollar Index (DX) 78.98.  The dollar gain of .63 for the week hardly seems impressive but considering it was as low as 77.43 last Wednesday the turn around on Friday qualifies for our “bell ringer” of the week since it moved in the same direction as equities which have been negatively correlated for some time.  As with the breakout of the SPX two weeks ago, the potential for the dollar to become positively correlated with equities once again should be carefully watched. iShares Barclays 20+ Year Treasury Bond (TLT) 90.49.  After the revised GDP report long- term bonds rose 3.7% then last week they made a round trip and declined 4.6% on the better than expected unemployment report.  We wonder if this could mean a return to a period of rising equities, a rising dollar and rising long-term interest rates.  It is too soon to tell, but it is worthwhile considering the possibility.  NYSE McClellan Summation Index 1356.65.  The potential divergence we mentioned last week has faded as the breadth index closed above the prior high along with the major equity indexes.  For now, the potential divergence is no longer a concern.  For the week, our index increased 240.81 points as the breadth continued to improve. Baltic Capesize Index (BCI) 4444.  Beginning this week we are moving our dry-bulk shipping index from the strategy section since we think there is value in watching it as a leading economic indicator of industrial activity.  For the week, it was lower by 941 points or 17.5%, a significant decline.  However, we note that this is August and a slow period in the shipping industry.  If the index continues to decline in September this would be a concern as it may be indicating that China’s raw material restocking has been completed as previously reported.
Strategy The two strategies we mentioned last week are to trade the breakout or trade the retracement.  There will be a pullback at some point and it could come at any time.  For the SPX there is previous resistance at 1,000 and then again, at 1,100 either place could trigger a pull back.  However, since we are now above 1,000, watch the 1,100 level.  On the other hand, there may be no pullback until we reach the minimum measuring objective at 1233.29.  At every important level of the advance from the March low, there are many who have been citing reasons why it can’t last, yet it continues higher.  With a well-defined Head & Shoulders bottom along with its measuring objective, we think the chances are good it will continue up to at least 1233.29 and last until October.     We continue to favor stocks and ETF’s that have broken out with the broad market, but remain wary of those with potential double top formations.  This no longer includes our favorite copper company, Freeport-McMoRan Copper & Gold Inc. (FCX) 63.41 as it gapped higher on the opening August 3rd and remained above the 60 resistance all week.  We suggest increasing long positions using bull call spreads and short puts in several sectors and we have some ideas in the sections below after we do some adjustments.
Portfolio Adjustments Our high-implied volatility Sequenom Inc. (SQNM) 5.02 bull put spread we suggested in Digest issue 29 lived up to its volatility forecast by gapping lower after reporting earnings, however the implied volatility also declined thereby reducing the loss on the short put.  We suggest unwinding this position by buying back the short September 6 put while keeping the long September 4 put in the event it continues to decline.  Here are the trade details to unwind this one.
The mid price on Friday was a debit of 1.45 as shown in the “Price” column above.  Adjusting for time decay the estimated price on Monday should be 1.42 as shown above in the “E Price” column.  Use the delta to adjust for any change in the stock price. Las Vegas Sands Corp. (LVS) 12.52. In IVolatility Trading Digest™ Volume 9, Issue 21, Trimming the Hedge, dated June 1, 2009 we sold an Iron Condor when LVS was 9.91. Subsequently, we sold an August 9 call and then we were assigned stock from the July 9 in- the- money put.  This resulted in a covered call with a stock basis of $756.50, after subtracting the four credits from the Iron Condor.  Since it is now likely we will lose our stock by assignment at the August expiration, but our basis will have been further reduced to $675 and we will receive $900 for the stock.  Since the stock has now broken out above the 12 resistance we want to establish another short put to replace our stock that will be assigned.  Here is the replacement suggestion.
The mid price for this put sale on Friday was a credit of .625 as shown in the “Price” column above.  Adjusting for time decay the estimated price on Monday should be .59 as shown above in the “E Price” column. The “Greeks” are based upon Friday numbers, before the position is established – they will be reversed when the put is sold.  Use the delta as shown above to adjust for any change in the stock price when placing the order.
IVOLopps™  Best Calendar Spread As a regular feature on our home page, we offer the “Best Calendar Spread” suggestion found at the bottom of the “Options Data Analysis” and the “Rankers & Scanners” sections.  The scan result is a long call calendar spread based upon the differential between the implied volatility of the near term call compared to the implied volatility of the deferred call.  Here is the selection last Friday. Amgen Inc. (AMGN) 60.49 is a leading biotechnology company developing and marketing human therapeutics based on advances in cellular and molecular biology.  The stock gapped higher on July 8th continued higher another 5 points, but is now correcting and may attempt to fill the gap.  The calendar spread suggested by the scanner is short the August 60 call and long the Jan 60 call, but since the VIX futures are telling us to beware of October we suggest modifying the position by using the Oct 60 call not the Jan 60 call.  With a current Historical Volatility of 44 and an Implied Volatility Mean Index of 39.29, here is the modified calendar spread idea.
The mid price for this spread on Friday was a debit (Dr) of 1.33 as shown in the “Price” column above.  Adjusting for time decay the estimated price on Monday should be 1.49 as shown above in the “E Price” column.  The “Greeks” are based upon Friday numbers, assuming the position has been established so they are reversed for the sold call shown above.  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. Watch the stock price before the Aug expiration and if it appears the short August 60 is going to expire worthless then make sure to sell the Sep 60 call the Friday before the Aug 60 expires to avoid uncovered stock price risk with the long Oct 60 call.   Trending This next selection comes from our scanner for high and low implied volatility ranges for the past year.  This one is at the low and since we are expecting a seasonal rise in implied volatility going into October we want some long volatility trades.  Here is one that is trending upward with long volatility or vega. NVIDIA Corporation (NVDA) 13.71.  NVIDIA provides visual computing technologies designed to generate interactive graphics on consumer and professional computers. With a current Historical Volatility of 40 with the Implied Volatility Index Mean at 45.50, consider this bull call spread.
The mid price for this spread on Friday was a debit (Dr) of .95 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.  The “Greeks” are based upon Friday numbers, assuming the position has been established so they are reversed for the sold call as shown above.  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. Use a close below the well-defined support at 12 as the SU (stop/unwind).  The difference between the strike prices defines the theoretical maximum gain which is 2.05 (3.00 - .95) for risk reward in excess of 2 with a position that has a limited and defined maximum loss of the initial debit that can be further reduced by selling or unwinding on a close below 12.  In addition, the position benefits if the implied volatility rises since it has .56 positive vega shown above.  Load the Boat     For our model portfolio, in order to load the boat, or referring to our illustration in the heading, the ship, we are going to modify our usual format and list several put sales in one table.  This is a diverse group from several sectors having broken out to the upside.  We know there is a high probability of pullbacks and retests of the breakouts.  They are all expiring in Sep so if the pullbacks are delayed we will have earned time premium, if they come sooner we have the opportunity acquire stock by assignment at or near the breakout levels.  We are keeping an eye on the high premium being paid for the Oct VIX futures so for now we want to avoid any further Oct risk.  Selling puts requires a good bit of margin so we want to select lower priced stocks to reduce the initial margin requirements, although we are now using only about one-third of our available margin. Make sure to do the fundamental work, check the put/call ratios volume traded and other important variables.  Set stop/unwind levels or make the decision to take the stock by assignment when placing the orders. The first on the list comes from Friday’s Trend Selection idea found at the bottom of the “Options Data Analysis” and the “Rankers & Scanners” sections of our home page with a bullish rank of 77.78%.
All of the above ideas are based upon the mid prices on Friday as shown in the “Price” column above.  Adjusting for time decay the estimated prices on Monday should be as shown above in the “E Price” column.  The “Greeks” are based upon Friday numbers, before the positions are established – they will be reversed when the puts are sold.  Use the deltas as shown above to adjust for any change in the stock price when placing the order.
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