Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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In this issue, we offer another silver trade idea. We don’t know if gold and silver are ready to breakout to the upside, but if they do, we want to have another long position. Then we offer two more low priced chasing performance suggestions followed by a return to China as we update an earlier trade idea.
Market Review S&P 500 Index (SPX) 1016.40. Last Tuesday there was serious SPX selling that left this important market indicator 12.53 points lower, or 1.2%, at the week’s end. Despite the difficult week are still focused on the upside measuring objective at 1233.29, from the large Head & Shoulders bottom. E-mini S&P 500 Future (ESU9) 1014.00. The September e-mini futures contract closed the week 13.50 points, or 1.3% lower. Last Tuesday it declined 23.25 points on volume of almost 3.25 million contracts the highest since June 11th. Since high volume on a down day is bearish, the bulls were sent a clear warning signal. In addition, open interest, Thursday to Thursday contracted by 34,572 contracts a further negative for the bulls to consider. For the uptrend to continue, open interest needs to keep expanding. After last Tuesday’s high volume down day, we will be carefully watching open interest. For now, we give it a small yellow caution flag. S&P 500 Index Implied Volatility (IVXM). The volatility measures were mostly higher last week as our Implied Volatility Index Mean added .70 to end at 22.14 as the VIX ended .35 higher at 25.11, after spiking as high as 29.57 last Wednesday it still managed to close below the 20-day moving average at 25.83. The September VIX futures premium over cash, decreased from 13.49% to 9.92%, while the October premium decreased from 23.18% to 21.27%. The Implied Volatility Mean Index of the VIX options decreased from 96.87 to 90.76. The substantial premium for the October futures indicates a continuing willingness to pay the higher premium for downside protection in October. US Dollar Index (DX) 78.14. Without responding to the decline in equities, the dollar index declined .23 for the week. If changes in DX are related to changes in gold and silver, this too was not apparent last week. This may all change as more market participants return to work from the summer holiday season. iShares Barclays 20+ Year Treasury Bond (TLT) 95.21. Long-term bonds continued higher until last Wednesday and then rolled over on Friday closing the week 1.30 lower. If TLT closes below 95 it will most likely return back to support at the 90 level. A long position in TBT, the leveraged inverse ETF, would be one way to participate in this range trade. NYSE McClellan Summation Index 1114.67.  The breadth indicator declined 230.72 points along with the broad market indexes and giving no indication of divergence. Baltic Capesize Index (BCI) 3651. Last week the long route dry-bulk shipping index declined again, this time another 295 points or 7.5%. While equity prices in China may be turning up the continuing decline of the shipping index is a real concern. Until we see this indicator turn higher, we will keep this caution flag flying.
Strategy Last week a second theme developed to compliment low priced stocks that we reviewed in last week’s Digest, as gold and silver made a quick move up to their previous resistance areas. We are carefully increasing our allocation to the sector in the event they breakout and continue higher. Having disappointed many times in past we remain somewhat skeptical they can continue higher without encountering considerable resistance. The China indexes are looking better so we return to that sector and reinstate one trade idea we previously closed to reduce risk when it declined below its upward sloping trendline. Since we are still expecting to see higher market implied volatility going into the fall and the slope of the VIX 20-day moving average now appears to be increasing we continue to suggest the use of long volatility or Vega strategies when possible. High Volatility Event Report Allos Therapeutics, Inc. (ALTH) 7.91. Last week’s high volatility event trade is still in progress as the first of the two scheduled events occurred on September 2, 2009 as the stock price traded a range between 7 and 8. The implied volatility of our short Oct 5 put declined from 209 to 180 and the price declined from .85 to .50. Since this was an implied volatility trade and it remains high, we will wait for the final FDA approval due on September 24th before closing this one. The Silver Story In IVolatility Trading Digest™ Volume 9, Issue 32, The Season for Gold, dated August 17, 2009 and then again, in IVolatility Trading Digest™ Volume 9, Issue 33, Seasonal Gold 2.0, dated August 24, 2009 we suggested new positions in the precious metals sector using silver and gold. Since they have both quickly moved up to their previous resistance highs we offer some additional background information and another idea for a potential upside breakout. Gold (cash) at 994.40 is within 12.03 of testing the previous high at 1006.43 made on February 20, 2009. That move began on October 24, 2008 at 682.75. The current uptrend began with at the low of 905.09 on July 8, 2009. Once above 1006.43 there will be no previous resistance to overcome. Silver (cash) 16.23 is just within .115 of testing resistance made on June 3, 2009 at 16.345. However, there is 6 months of previous resistance in the 16 area as well as the July 14th high of 19.475 and the March 2008 high of 21.349. There is a lot of resistance for Silver to overcome. Silver bulls point out the gold to silver ratio at 61 is abnormally high, indicating silver is underpriced relative to gold. Since more than one-half of silver production is a “by-product” from copper, lead and zinc mining there is some doubt about the current relevance of the gold to silver ratio. They also point out China is now encouraging its citizens to buy gold and silver and since silver is less expensive it is more likely to be accumulated by retail investors. Our view is gold and silver are both overbought and are facing resistance at the current levels. In the event the momentum continues, we think a carefully structured low cost position is a prudent strategy. As an addition to the current portfolio, here is one idea to consider. Silver Wheaton Corp. (SLW) 11.59. Vancouver based SLW has long term contracts to purchase all or a portion of the silver production from mines in Mexico, Sweden, Peru, Greece, Portugal, Canada and the United States, at a low fixed cost. Operating at low a low cost provides leverage to increases in the silver price while mitigating the downside risks associated with traditional mining companies and they do not sell silver forward. Consider this combination using a short put and a call ratio backspread. Short put - Step 1.
The mid price for this put sale on Friday was a credit (Cr) of .725 as shown in the “Price” column above. Adjusting for time decay the estimated price on Tuesday should be .685 as shown above in the “E Price” column. The other “Greeks” are also based upon Friday numbers, before the position is established, and will reverse when the put is sold. Use the delta as shown above to adjust for any change in the stock price. Call ratio backspread - Step 2.
The mid price for this spread on Friday was a credit (Cr) of .05 as shown in the “Price” column above. Adjusting for time decay the estimated price on Tuesday should be about .09 as shown above in the “E Price” column. We are buying 2 Oct 12.5 calls that were .625 each on Friday and should be about .585 each on Tuesday, total 1.17 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. When the put sale is made as shown in the put section above the Greeks will be reversed and then when combined with the call back spread this will be the approximate combination result. Position Summary
The result should be a credit of about .775 and the equivalent of a 53 share long position. However, for return on investment purposes the estimated initial margin requirement of 383.80 should be considered as the basis for the computation. At this price level both Theta (time decay) and Vega (volatility) changes have been fairly well offset. Use a close below 10 as the SU (stop/unwind). In this event, the decision will be needed to keep the Oct 11 short put open and accept stock by assignment for later call sales. Low Priced Stocks Following–up to the low priced stock theme we introduced last week in IVolatility Trading Digest™ Volume 9, Issue 34, Chasing Performance, dated August 31, 2009 here are two more ideas. The first is number two from Fridays’ Top 5 list of increasing implied volatility. Sprint Nextel Corp. (S) 3.81. Sprint Nextel offers wireless and wireline communications on networks that utilize CDMA and iDEN technologies. For the last three quarters, it reported losses and the estimate for the next quarter is for another .03 loss per share. The stock appears to be attempting an upturn at the 3.50 support level. On Friday call volume exceeded put volume 5 times as the options Implied Volatility Index Mean rose 18% to 78.65 apparently on the news they will be the first to offer phones using Google’s Android software in October. With a current Historical Volatility of 57 consider this long call spread.
The mid price for this spread on Friday was a debit (Dr) of .20 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 in price of the underlying or use the net spread delta for spread orders. The table above is for one spread and for this position we suggest a five spread position so the totals would then be a debit of 1.00 (.20 x 5) with a net delta of 129.70 (25.94 x 5), or the equivalent of a 130 share long position at this price level. Use a close below the pivot at 3.5 as the SU (stop/unwind). IVOLalerts™ From last week’s alert, we return with a suggestion for the low priced stock theme from last week’s Digest. Citigroup, Inc. (C) 4.85. With a current Historical Volatility of 75 consider two of these call ratio backspreads. Here is the data for one spread using Friday’s numbers.
The mid price for this spread on Friday was a credit (Cr) of .19 as shown in the “Price” column above. Adjusting for time decay the estimated price on Tuesday should be .21 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. For the two spreads the estimated credit should be about .42 (.21x2) and the total delta would be about 21.34 (10.67x2). Use a close back below the well-defined pivot and support at 4 ½ as the SU (stop/unwind). Return to China
iShares FTSE/Xinhua China 25 Index (FXI) 41.13. Last Monday we closed our long call spread as the index gapped lower. Now with an upside reversal we again suggest a new long call spread. It is not yet clear the uptrend will resume so until it crosses back above the upward sloping trendline we suggest a cautious approach. With the current Historical Volatility of 30.68, consider this long call spread.
The mid price for this spread on Friday was a debit (Dr) of .1.125 as shown in the “Price” column above. Adjusting for time decay the estimated price on Tuesday should be about 1.11 as shown above in the “E Price” column. Use the deltas for each leg to adjust for any change in the price of the stock or use the net spread delta for spread orders. Use a close below the last pivot made on September 1, 2009 at 38.33 as the SU (stop/unwind).
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IVolatility.com Bookstore. In addition to the vast number of articles and information on our web site, browse in our bookstore for more reference information and material. In next week’s issue, as volume is likely to increase as more market participants return from summer vacation, we will focus on the market direction.

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