Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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From a technical analysis perspective, the stage is set for a meaningful decline in equities over the next few weeks.  In this Digest we briefly review the technical explanation for the anticipated decline  and offer bear spread alternative suggestions along with a bull spread idea for the” risk off” trade followed by a special situation idea.  We begin with a look at the current technical condition.
Strategy With reference to last week’s Digest Issue 27 and the suggestion to watch for a minor trend change indicator for the S&P 500 Index it came on Friday as a key reversal that can be seen using a weekly chart.     Based upon the S&P 500 Index the operative technical analysis pattern is the Head & Shoulder Top with a minimum measuring objective down at 862.  A detailed chart in Digest Issue 26 showed the downside-measuring objective at 862.  Since then it formed a third right shoulder with the most recent rally and now if the low of 1011.40 made on July 1 is broken then a new Head & Shoulders Top with three right shoulders will be set off implying a new downside-measuring objective at 803. This is how we are expecting it to unfold. Retest the 1011.40 low made July 1.  Then after attempting to form a double bottom the retest will most likely fail and SPX will continue going lower. Reach the minimum downside-measuring objective from the second right shoulder at 862 as described in Digest Issue 26. After crossing below 1011.40, it sets off the second minimum downside-measuring objective of 803 from the third right shoulder as it continues lower. If the SPX begins to trend lower, as described above, it could decline without a significant increase in implied volatility.  Therefore incorporating volatility into the scenario, using the VIX as the measure,   our best estimate is a range between 24 and 36.  While the implied volatilities of individual stocks could be much higher and offer volatility opportunities as well as downside directional opportunity our assumption for the major indices is a limited volatility range with little additional advantage offered by using ratio spreads.
IVOLopps™ For the expected downside, or to hedge existing long positions, we suggest debit bear put spreads and credit call spreads. We went to our RT Spread Scanner using the Top 200 stocks and ETFs by options volume and the S&P 500 Index for ideas. For long bear put spreads, we used the midterm selection from September to January to reduce time decay and for some edge, we selected an implied volatility difference of 5 percentage points between the put bought and sold. From the 50 scan results, we selected one index, one ETF along with 4 individual stocks that are, not surprisingly, all due to report earrings soon and have high put call ratios indicating hedging activity with puts.  HV=Historical Volatility   iShares Russell 2000 Index (IWM) 61.07.  HV 32.89; put call ratio 3.15.
Use a close above 64.44 as the SU (stop/unwind). Direxion Daily Financial Bull 3X Shares (FAS) 20.14.  HV 93.12; put call ratio .9
Use a close above 22.20 as the SU (stop/unwind). American Express Company (AXP) 41.38.  HV 41.78; put call ratio 3.0.  Earnings expected Jul 22 after the close.
Use a close above 44 as the SU (stop/unwind). Abercrombie & Fitch Co. (ANF) 33.25.  HV 54.68; put call ratio 1.5.  Earnings expected Aug 12 before the opening.
Use a close above 35.20 as the SU (stop/unwind). Freeport-McMoRan Copper & Gold Inc. (FCX) 60.08.  HV 55.77; put call ratio 2.75.  Earnings expected Jul 21 before the opening.
Use a close above 66.15 as the SU (stop/unwind). Las Vegas Sands Corp. (LVS) 23.50.  HV 56.25; put call ratio 1.5.  Earnings expected Jul 29 after the close.
Use a close above 24.80 as the SU (stop/unwind). Next we set the RT Spread Scanner to find some short call credit spreads candidates by selecting short term from August to September using at-the-money calls with a least 5 points difference between the strikes and 5 points difference between the bought and sold legs. Here are some selected call credit spread ideas to consider.  Allegheny Technologies Inc. (ATI) 44.73.  HV 57.93; put call ratio 1.25.  Earnings expected Jul 28 before the opening.
Use a close above 49.30 as the SU (stop/unwind). Cliffs Natural Resources Inc. (CLF) 46.55.  HV 69.0; put call ratio 1.3.  Earning expected Jul 28 after the close.
Use a close above 51.30 as the SU (stop/unwind). Starwood Hotels & Resorts Worldwide Inc. (HOT) 43.17.  HV 52.89; put call ratio 5.75.  Earnings expected Jul 22 before the opening.
Use a close above 47.35 as the SU (stop/unwind). KLA-Tencor Corporation (KLAC) 29.23.  HV 46.66; put call ratio 4.00.  Earnings expected Jul 22 after the close.
Use a close above 32 as the SU (stop/unwind). SanDisk Corp. (SNDK) 41.93.  HV 47.77; put call ratio .9.  Earning expected Jul 22 after the close.
Use a close above 46.80 as the SU (stop/unwind). For another approach to "risk off" trades here is a long call spread using the long Treasury Bond ETF. iShares Barclays 20 + Year Treas Bond (TLT) 100.80.  HV 14.58; put call ratio .55.
Use a close below 98.18 as the SU (stop/unwind).   Special Situation Here is an arbitrage trade idea in a sector with timely seasonal support. SandRidge Energy, Inc. (SD) 6.58.  HV 36.57; put call ratio .35. SandRidge completed their merger with Arena Resources on Friday removing the arbitrage shorting pressure that has held down the stock price.  Now the company will be a balanced energy producer with the more profitable crude oil portion hedged to 2012 at $87.  With the merger completed, the implied volatility should now decline.  Consider this put sale opportunity for the decline in implied volatility.
In the event the stock closes below 7 at the September expiration plan to take the stock by assignment as then sell calls against the stock.  All of the suggestions above are based upon last Friday’s closing prices using the mid price between the bid and ask.  On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.   Summary Based upon the current technical condition of the S&P 500 Index, and not based upon the fundamentals of any particular ETFs or stocks it looks as if the markets are about to make another down move after completing a complex Head & Shoulders Top.  Hedging strategies or short positions using spreads are suggested.
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In next week’s issue, we will return with a complete review of our market indicators along with a review of the S&P 500 Index developments and a strategy update.

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