« March 2012 »

IVolatility Trading Digest™

Volume 12, Issue 12
VIX Futures Calling

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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In our last Digest, once again we suggested using more hedging strategies based upon our indicators with special emphasis placed upon the increased VIX futures premium along with the expanding numbers of open contracts. We return to update the VIV futures data in the strategy section below followed by an update for our latest hedge suggestion and then three interesting new earnings report ideas along with Friday's number one IV/HV ratio pick.



StrategyReferring to the market review in Digest Issue 11 we note the SPDR Homebuilders (XHB) 21.51 continued trending higher while the iShares Dow Jones Transportation Average Index (IYT) 95.50 made an impressive advance Thursday followed by another on Friday as it rose back up to challenge the February 3 high at 96.13, where it then meet resistance, closing off.10. In addition, the euro advanced slightly adding further support for equities.

However, our other important indicators continue to make the correction case.

Market breadth did not improve as the NYSE McClellan Summation Index 891.94 declined 20.46, despite the continued advance in the major indexes, increasing this important negative divergence.  

Second, our VIX futures premium closed at an all time high reflecting the extent of increased hedging activity. Here is the data.

S&P 500 Index Implied Volatility (IVXM). Last week Implied Volatility Index Mean declined from 14.16 to 12.54, while the CBOE Volatility Index® (VIX) declined from 17.11 to 14.47. 

The table below shows the VIX cash compared to the next two futures contracts as well as our calculation of Larry McMillan's day-weighted average between the first and second months.



The day weighting applied 8% to the March contract that will expire Wednesday morning and 92% to April resulting in the average premium of 6.69 or 46.26 shown above. Our alternative volume weighting between March and April results in a 33.22% premium.

For this short-term indicator the premium to the cash is a SPX sell signal suggesting professional expectations for the cash to increase toward the futures price. These are the highest premium levels recorded since we have been collecting this data. In the past, premium levels in excess of 20% usually preceded corrections. The continued expansion of open interest last week closing up 20% at 332,948 contracts as of Thursday, confirms the additional hedging activity.

Another gauge we follow is the CBOE S&P 500 Skew Index (SKEW) 138.43 that indicates purchase activity of out-of-the money S&P 500 Index puts used for downside protection. While swinging wildly during the week it closed three days above the previous all time high range of 130, indicting active index put buying confirmed by the high SPX put-call ratio at 2.10.

Based upon the above we continue to suggest hedging long portfolio risk.





Last week in Digest Issue 11, we suggested a SPDR S&P 500 Index (SPY) 140.30 put ratio backspread. Our trade plan was to close the position in the event SPY closed above 140, which occurred on Thursday as SPY closed at 140.72. Accordingly, we booked the close on Friday for a net .22 credit after losing .39 from the original credit of .61 that we recorded the previous Monday. Although our initial forecast was wrong, we were able to salvage the position since we moved quickly to close it eliminating our time decay risk from the extra long put. While our indictors above continue to suggest a market correction, we will wait to see a close below the current upward sloping trendline at 137.50 before renewing this one.


Earning Report Trade Ideas

Oracle Corporation (ORCL) 29.74. The last earnings report suggestion we made for this enterprise software company in Digest Issue V11 49 was a combination long call spread with a short put. At the time, expectations were more positive, but since they missed on the last report, we will use a different strategy this time based entirely upon the expectation of a decline in implied volatility after the scheduled Q3 report on Tuesday March 20 after the close. Expectations are for 9 billon in revenues, with a consensus earnings estimate of .56 per share and a whisper estimate of .57.

Here is the options data. 

The current Historical Volatility is 17.31 and 16.97 using the Parkinson's range method, with an Implied Volatility Index Mean of 29.94, up from 26.03 last week. The IV/HV ratio is 1.73 and 1.76 using the range method to calculate the HV. Friday's put-call ratio was bullish at .52 while the volume was 54,576 contracts traded compared to the 5-day average volume of 72,570 contracts.

Consider this short and long straddle combination using the March 23 weekly options.



Compared to the implied volatility mean index of 29.94 and the historical volatility of 16.97 this straddle has a good implied volatility edge.

Now for the second part,



The combination of both straddles has a net debit of .48 and we expect the implied volatility of the March 23 options to decline substantially while the decline in the April options should be considerably less. We will have the results by the end of week and plan to close it on Friday.

Lululemon Athletica Inc. (LULU) 72.04. This Vancouver based company, catering mostly to women, sells expensive yoga and workout clothing along with accessories in 140 stores in Canada, the U.S. and Australia.

Scheduled to report Q4 earnings Thursday March 22 before the opening the consensus estimate is .49 per share with a whisper estimate of .53 per share on 360.3 million in revenues.

Here is the necessary options data.

The current Historical Volatility is 31.37 and 25.73 using the Parkinson's range method, with an Implied Volatility Index Mean of 45.55, up from 44.29 last week. The IV/HV ratio is 1.45 and 1.77 using the range method to calculate the HV. Friday's put-call ratio was a very bullish .40 while the volume was 37,146 contracts traded compared to the 5-day average volume of 20,980 contracts.

Since the stock has risen up from 65 in the last week or so, a better than expected report appears already to be in the price making it vulnerable to a selling off after the release.  

Since there is a good implied volatility differential we suggest using the straddle strategy again.

First the March 23 weeklies,



Part 2,



Once again, we expect the implied volatility of the March 23 options to decline substantially after they report earnings while the decline in the April options should be considerably less. This one has a net debit of 2.78 and the plan is to close it on Friday.

KB Home Common Stock (KBH) 12.76. With the homebuilder's index in an uptrend here is one to consider on the assumption the trend continues, despite our indicators suggesting a correction is due.

Scheduled to report Q1 earnings Friday March 23 before the opening the consensus estimate is for a loss of .23 per share, but less than last year.

Here is the options data.

The current Historical Volatility is 61.83 and 46.53 using the Parkinson's range method, with an Implied Volatility Index Mean of 64.28, up from 60.66 last week. The IV/HV ratio is 1.04 and 1.38 using the range method to calculate the HV. Friday's put-call ratio was a very bullish .20 while the volume was 16,742 contracts traded compared to the 5-day average volume of 10,330 contracts.

For this one we suggest a put sale.



Short of a major market correction, we think the chances are good that the upward sloping trendline now at 11.25 will hold, but be prepared to take the stock by assignment if it closes below 11 on the April expiration.


High IV/HV Ratio

McMoRan Exploration Company (MMR) 13.40. McMoRan is one we have suggested several times in the past that always seems to disappoint, but always seems to stay in the same range while maintaining high options implied volatility. Their exploration work in the shallow water ultra deep Gulf of Mexico has attracted the attention of Chevron and in recent months resulted in a partnership offer on the Lineham well and McMoRan agreed. It is significant that giant Chevron wanted MMR to join it in this project as an equal partner. They are close to testing/producing the first of many wells that are pushing very significant technological boundaries.

We think expected test results could be the motivation of the increase in option prices reflected by the high IV/HV ratio.

Here are the relevant option numbers.

The current Historical Volatility is 39.35 and 37.49 using the Parkinson's range method, with an Implied Volatility Index Mean of 109.11, up from 113.04 last week. The IV/HV ratio is 2.77 and 2.91 using the range method to calculate the HV. Friday's put-call ratio was a bearish at 1.55, most likely due to hedging activity, while the volume was 33,019 contracts traded compared to the 5-day average volume of 23, 770 contracts.

For this one we suggest a strategy that can benefit if they report blowout test results that some have been expecting for a long time from the ultra deep shallow Gulf of Mexico.



The implied volatility edge is in the short April 12 put and if it closes below 12, on the April expiration be prepared to take the stock by assignment and then sell calls against the long stock, as the implied volatility will most likely remain attractive.  

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. To follow the progress of the suggestions we will book the trades using the closing mid prices on Monday.


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Based upon our market indicators the weight of evidence leads to the conclusion professional traders and strategists are expecting a correction. Accordingly, we suggest being ready with more hedging strategies to be implemented as soon as the major indexes begin showing signs of rolling over.


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In next week's issue, we will update our market indicators and review the hedging plans.


Finding Previous Issues and Our 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. Another way to find them is the Table of Contents link in the blog section of our website.

Next week's 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 us to look at a specific stock, ETF or futures contract, 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



The ORCL earning play is essentially two calendars of 32 c and 32 p. From that point of view, why do both put and call, why not just double the call calendar contracts since it's cheaper? 40c vs 48c.

Posted by Jimmy on March 19, 2012 at 01:27 PM EDT

On March 19, the VIX went up but the VXX went down. Could you explain how the divergence happened?

Thank you.

Posted by aldo on March 19, 2012 at 06:13 PM EDT

Hi, Cd you pl comment on where TRP (Transcanada Corp) is heading?

Posted by Kim Woo on March 20, 2012 at 02:21 PM EDT

hope this works

Posted by James Stewart ( on March 20, 2012 at 04:10 PM EDT


Thanks for the ORCL comment. You are right; it is also less complicated to put on.


Posted by Jack ( on March 25, 2012 at 07:48 PM EDT


Thanks for the VIX, VXX question. This is complicated stuff. The VIX and the VIX futures are different things, the VXX uses futures and the March contracts expired last Wednesday, the last trading day was Tuesday so rollover was involved as the positions were rolled over into the higher priced April contracts. VXX will most likely always have this rollover cost.


Posted by Jack ( on March 25, 2012 at 07:59 PM EDT


Thanks for the Transcanada question. It appears to be in a well-defined trading range between 40 an 45, with a decent dividend yield. According to many, the energy infrastructure companies will do well as North America increases its use of natural gas for industry and perhaps even transportation. This quality company should do well. In the meanwhile, you could supplement the dividend income by selling it at 45 and buying it at 40.


Posted by Jack ( on March 25, 2012 at 08:13 PM EDT


Thanks for giving it a try. Yes, it works and I usually respond sooner.


Posted by Jack ( on March 25, 2012 at 08:16 PM EDT

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