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Great Expectations, a Charles Dickens novel is regarded as one of his greatest and most sophisticated novels having been adapted for stage and screen over 250 times. Of course, our expectations refer to quarterly earnings reports and the response of stocks when they report earnings that are better than expected by the analysts. In the next few weeks, there will be many more opportunities based upon expectations. We offer one earnings expectation suggestion after looking at crude oil and a few comments about last week’s earnings trades, then a high-implied volatility biotech idea and a replacement put sale. We begin with the market review.
Market Review S&P 500 Index (SPX) 1087.68. SPX continued higher with a gain of 16.19 or another 1.5%, crossing back above the active upward sloping trendline and proceeding higher and making a new high for this advance that started from the July 872.81 low. Accordingly, we have now redrawn our trendline from the July 10, 2009 low of 872.81 to the last pivot on September 3, 2009 at 992.25. The resumption of the uptrend increases the probability of reaching the minimum upside measuring objective at 1233.29, from the large Head & Shoulders bottom that we explained in Digest issue 36. E-mini S&P 500 Future (ESZ9) 1082.25. For the week the December E-mini future contract was 14.25 points or 1.3% higher. Volume continues to be light as there were no days last week when the volume exceeded 2 million contracts as open interest, Thursday through Thursday increased 35,971 contracts. On Friday, it made a key reversal, a new contract high but a lower close that was not confirmed by the cash SPX. Since it occurred on low volume there is doubt it will remain a valid key reversal, especially if open interest increased Friday. For the bull market to continue the E-mini needs increasing volume and increasing open interest as it advances. S&P 500 Index Implied Volatility (IVXM). Our Implied Volatility Index Mean was lower by 1.12 at 19.36 while the VIX declined 1.69 to 21.43. The VIX 20-day moving average is 24.52 and considerably above the current VIX close. The risk premium measures continued higher last week as the cost of portfolio insurance rose once again. The VIX November futures over cash premium increased 3.46% to 18.06%, December declined .2% to 16.8% but January increased by 4.56% from 20.5% to 25%. The implied volatility of the VIX call options also increased with the November 25 calls advancing to 120.60 from 114.35. This means higher prices are being paid for VIX calls used for hedging. US Dollar Index (DX) 75.60. DX continued lower last week declining .83 or 1.09% with a noticeable drop of .425 on Wednesday quashing any attempt for possible double bottom from 76. This seems to have supported SPX as it crossed back above the upward sloping trendline while crude oil and commodities promptly followed by moving higher. iShares Barclays 20+ Year Treasury Bond (TLT) 95.45. Long Treasury bonds also continued lower declining .45 or .47%. With rising equities and commodities, the risk preference argument seems to offer the best explanation. NYSE McClellan Summation Index 1154.83. This index gained 1.96 points on the week as fewer stocks participated in the advance increasing concern about the developing divergence now quite noticeable on the chart. From the perspective of this indicator more issues need to participate in the advance or the major indexes may stumble. Baltic Capesize Index (BCI) 4061. Last week’s star stumbled and then recovered on Thursday and Friday ending the week lower by 46 or -1.12%. In the meanwhile, we see little improvement in the VLCC crude oil tanker rates at World Scale in the mid 40’s or about $22,000 per day. We would expect to see higher tanker rates along with higher crude oil prices.
Strategy Last week’s focus on the US Dollar Index was correct. The potential double bottom failed, the S&P 500 Index to crossed back above the upward sloping trendline and commodities continued higher. In IVolatility Trading Digest™ Volume 9, Issue 38, Oil Bears Return, dated September 28, 2009 the case was made for a seasonal decline in crude oil prices. Since then the December future contract has risen from 67.17 to 79.02. When prices defy their normal seasonal tendency it is usually a sign of a change in the normal supply and demand relationship, in this instance indicating stronger than normal seasonal demand for crude oil. If this were the case, we would expect rising crude oil tanker prices as more crude is shipped in to replace dwindling inventories. So far, this is has not been the case and perhaps tanker rates will start to rise soon or perhaps the only demand has been from the futures market as a result of dollar hedging and not physical crude oil demand. We remain cautious about declaring the end to this year’s crude oil seasonal decline, but in the meanwhile, we offer an updated picture of our oil bear.
Earnings Expectations The earnings expectations game is complicated since the rules continually change. Sometime when companies announce earnings that are better than expected the stock price rises. Other times they may decline if the better than expected earnings were anticipated and the stock price rose before the earnings we announced. Since the managements of most companies want to announce better than expected earnings they have a tendency to understate their guidance in the hopes of reducing expectations so can exceed them when they announce their earnings. In addition, revisions to previously announced guidance need to be considered. The problem is further complicated by the market sentiment on announcement day. If the market or a specific sector is being sold a good earnings report may be completely ignored. Some clues to watch include price increases or declines in the week to ten days before the announcement, along with changes in the options implied volatility and options volume. Last week in Digest issue 40, we ran a scan seeking implied volatility differentials resulting in two ideas with high near term-implied volatility. For the first, Intel Corporation (INTC) 20.18, we suggested an October 20 put sale and the stock initially traded higher on the better than expected report, but was then was heading lower by the end of the week as our puts expired just out- of- the-money. The second was Safeway Inc. (SWY) 23.31, where we suggested a long calendar spread, by shorting the October 20 call and buying the November 20 call. SWY also reported slightly better than expected earnings, but then the stock gaped open higher and closed up 1.40 on the day and up 1.99 for the week. Since large stock prices moves hurt calendar spreads, we had a small but disappointing loss by the week’s end. To cover the short October 20 call we bought stock on Friday and will now watch the remaining long November 20 call in an attempt to turn the loss into a gain if the stock continues higher. We will sell the Nov 20 long call on the first day it does not record a higher high and higher low. IVOLopps™ Continuing with the earnings report theme, we have another suggestion however, this one is conditional. SanDisk Corp. (SNDK) 20.98. SanDisk Corporation designs, manufactures, and markets flash memory storage products that are used in a wide variety of electronic products including digital cameras, personal digital assistants, digital music players, digital video recorders and smart phones. They are scheduled to report earnings on Tuesday October 20, 2009 after the close. Expectations are for .25 compared to a loss of .59 for the same quarter last year. In the second quarter, they reported .36 when the estimate was -.16. With a current Historical Volatility of 49.63 and a put call ratio of less than .3, consider this put sale on the condition that the stock has stopped declining from last Wednesdays high above 22 before reversing along with INTC and others in the semiconductor sector on what appears to be selling Intel’s good news and positive guidance. If so, the selling could be over by Tuesday.
The mid price for this put sale on Friday was a credit (Cr) of .55 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .50 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. We are not setting a predetermined SU (Stop/Unwind) as we would take the stock by assignment in the event the condition to implement the position was satisfied and then it decline once again and closed below 18 on the November options expiration. Biotech Top 5 For ideas we often look at the top 5 stocks based on IV Index Mean vs 30D HV located in the Rankers and Scanner section on our home page at  Top 5 stocks by implied volatility change. Here is number one from the list last Friday with an Implied Volatility Index Mean of 169.51 and a current Historical Volatility of 47.45 for a ratio of 5.07. Human Genome Sciences Inc. (HGSI) 19.96. Human Genome Sciences is a biopharmaceutical company with a pipeline of novel compounds in clinical development, including drugs to treat such diseases as hepatitis C, lupus, anthrax disease, cancer, rheumatoid arthritis and HIV/AIDS. They will discuss BENLYSTA and the Phase 3 BLISS-52 trial results during an Analyst & Investor Meeting after the market closes Tuesday, October 20, 2009, and then the second BLISS – 76 Phase 3 results will be released on November 2, 2009. The high Implied Volatility means the stock has the potential to make a large move, but on the November options expiration it will be either higher or lower but not both. Here is an Iron Condor suggestion for this high volatility opportunity consisting of a short call spread and a short put spread. Part one – call spread.
Part two – put spread.
The mid prices for the spreads on Friday are shown as Credits in the “Price” columns above. Adjusting for time decay the estimated prices on Monday should be about 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. One method to limit the risk is to limit the position size. On the downside, we can take the stock by assignment and then sell calls. The more substantial risk is to the upside above 25. Replacement Put Sale For our model portfolio, we had several October short puts expire and here is the replacement for part of a combination that began in Digest issue 36. Las Vegas Sands Corp. (LVS) 16.85. With a current Historical Volatility of 70.50, we suggest increasing this position to three short puts. Sell 3 November puts - here are the details for each one.
The mid price for these puts on Friday was a credit (Cr) of .80 each as shown in the “Price” column above. Adjusting for time decay the estimated prices on Monday should be .74 each 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 puts are sold. Use the delta as shown above to adjust for any change in the stock price. Use a close below the support at 15 as the SU (stop/unwind) alert.
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IVolatility.com Bookstore. In addition to the vast number of articles on our web site, take a browse through our bookstore for more reference information and material. In next week’s issue, we should have a better understanding of the counter-seasonal activity in the crude oil market and we will continue looking for earnings trades.

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