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The Temple of Heaven, literally the Altar of Heaven is a complex of Taoist buildings situated in southeastern urban Beijing, in Xuanwu District. The complex was visited by the Emperors of the Ming and Qing dynasties for annual ceremonies of prayer to Heaven for good harvest. It is regarded as a Taoist temple, although Chinese Heaven worship, especially by the reigning monarch of the day, pre-dates Taoism.

Initially called Temple of Heaven and Earth, it was constructed from 1406 to 1420 during the reign of the Yongle Emperor, who was also responsible for the construction of the Forbidden City in Beijing. It was extended and renamed Temple of Heaven during the reign of the Jiajing Emperor in the 16th century.

The Olympic Games will begin in Beijing on August 8, 2008 and the promotional events are well underway. We can expect to hear a lot more about China during the countdown to the Olympics. We can also expect to see numerous Chinese stocks in the top performance rankings. This issue will review a selection of the stocks that trade as ADRs from our volatility and options strategy perspective. But first a short review of the current US equity market.

Market Review

Market Implied Volatilities are somewhat higher than last week and now look as if they are going to establish mid 20s ranges. With the 10-Year Treasury Note now yielding 4.54, down from 5.30 in early June, interest rates are once again more supportive for equities. Last week 297 more NYSE issues advanced than declined giving a further lift to the McClellan Summation Index, now at –569.29, but up from its –917.08 level on August 17,2007. Contrary to the last four months this index is now confirming the upward market direction. In addition, we can make the case for defined Head & Shoulder bottom patterns in the DJ Industrials, the S&P 500 and the Russell 2000 Indexes. Further, the FTSE along with some other overseas indexes and stocks have not only recovered from the August 16, 2007 lows, but are now making new highs.

China

A review of the Top 200 stocks by Volume and Open Interest includes a good number of Chinese ADRs with listed options. While these issues are becoming more active we expect they will steal the limelight for the next year due in a large part to the Olympics promotional activities and careful news management from China.

One additional noteworthy development was the announcement on August 20, 2007 that mainland retail investors in China will be allowed to buy Hong Kong listed H shares. Before this government policy change they were restricted to the domestic A share market only. Since the shares of many companies trade in both markets they have seen the A shares rise and trade at higher price to earning multiple than the equivalent H share traded in Hong Kong. This new policy will have a positive impact on the Hong Kong market and H-share stocks as Chinese retail investors now expand their market activities to include Hong Kong giving them access for the first time to shares that are traded in Hong Kong but not Shanghai.

For the next year we expect a very favorable environment for this group.

In previous issues of IVolatility Trading Digest™ we included details and suggestions for Las Vegas Sands Corp. (LVS) 99.70 and Melco PBL Entertainment (Macau) Ltd. (MPEL) 13.03. The Las Vegas Sands opened the Venetian Macau on August 28, 2007, the biggest casino in the world and the biggest building in Asia, with their usual fanfare and promotional skill. The Venetian has three indoor canals for the gondolas and Chinese sampans. We expect a good number of visitors traveling to Beijing for the Olympics will also want to visit Hong Kong and Macau. The Venetian is likely to become a must see destination. In a favorable equity market environment both of these stocks should do very well. Consider bull call spreads and call ratio backspreads.

For your travel arrangements consider Ctrip.com International Ltd. (CTRP) 42.49, a company that we first suggested in IVolatility Trading Digest™ Volume 7, Issue 26, dated August 6, 2007. They provide travel-related services including hotel reservation, air-ticketing, packaged-tour services, as well as Internet advertising in China with a 52% market share of the travel agency business. This company seems well placed for the Macau excitement and the Beijing Olympics next summer. Consider this bull call spread:

Buy CTRP Dec 45 call QCTLI 3.65 IV 46.54 Delta .4898
Sell CTRP Dec 50 call QCTLJ 1.975 IV 44.92 Delta –.3238
Debit 1.675 Position net delta .1660

This position has a defined maximum downside risk of the 1.675 debit. On the upside the maximum position value is the difference between the strike prices or 5.00 (50-45). In this case the gain would then be the difference between 5.00 and the cost of 1.675 or 3.325. We are suggesting a December spread to allow sufficient time to reach the price objective. In order to preclude the maximum loss set a protective stop/unwind under the last pivot at 36.

Chinese Search Leader

Baidu.com, Inc. (BIDU) 208.20. This company offers a Chinese language search platform, which consists of Websites and online application software with a network of third party Websites and software applications. Its products include Baidu Web Search that allows users to locate information, products, and services using Chinese language search terms. With a 60% market share and 120,000 advertisers it makes most of its money selling text based ads placed on or near search results. Bidu is a likely beneficiary of increasing Olympics advertising expenditures.

Here are the volatility and price charts:

The orange colored distinctive peaks in Implied Volatility shown in the chart to the left occurred at the quarterly reporting dates on April 26, 2207 and July 25, 2007. On both reports the stock gapped higher and then the Implied Volatility rapidly declined. It seems likely that both volatility measures will return back into the 40% range before the next earnings report. From a volatility perspective we should wait for the anticipated volatility decline. From a price and market timing perspective we should establish a position sooner.

Trade Plan

DR: Leading Web search and advertising company in the rapidly growing Chinese advertising market. We would not expect growth rates to decline in the near future. Investors Business Daily currently gives BIDU number one ranking in their IBD 100 report showing it with 330% annual EPS growth and with a PE of 119. Last quarter’s sales increased 120%. A decline in the sales rate or EPS growth rate would not be favorable for the price of this stock. The plan is to sell the suggested bull call spread when the IV and HV return to the 40% area and then replace the position with a call ratio backspread that will benefit from the rising IV going into the next quarterly report.

SU: The stop/unwind should be set below the last pivot on the August 16, 2007 reversal.

Buy BIDU Dec 210 call BDULB 26.85 IV 56.61 Delta .5734
Sell BIDU Dec 220 call BDULD 22.25 IV 55.57 Delta –.5158
Debit 4.60 Position net delta .0576

With this position we have a defined maximum downside risk of 4.60. The maximum upside position value is the difference between the two strikes prices or 10 (220-210). In this example the gain would be the difference between 10 and the cost of 4.60 or 6.40. Again by using December calls we are allowing sufficient time to reach the price objective. Our stop/ unwind is a full 48 points below the current price so we are most likely risking the entire 4.60 debit. One of the advantages of using spreads is that they give us an affordable opportunity to participate in the potential appreciation of a high dollar priced stock. In addition, while we are waiting for IV and HV return to our forecasted volatility levels we are protected from the decline (or rise if there should be one) of volatility and time decay.

More Chinese Top 200

Once again while reviewing the Top 200 stocks by Volume and Open Interest we noticed several other Chinese ADRs on the list. They are clearly in focus and out performing US domestic stocks.

PetroChina Co. Ltd. (PTR) 144.33. This company engages in petroleum and natural gas related activities in the People's Republic of China. It operates in four segments: Exploration and Production, Refining and Marketing, Chemicals and Marketing, Natural Gas and Pipeline operations. Both IV and HV are now high. We call this Type II high volatility and expect they should both be declining. We suggest considering medium term bull call spreads for the direction without the expected declining volatility risk. Alternatives seeking to benefit from the current high volatility include near term covered call sales and put sales.

China Mobile Limited (CHL) 67.79, provides mobile telecommunication and related services in Mainland China and Hong Kong. Its services include local calls, domestic long distance calls, international long distance calls, intra-provincial roaming, inter-provincial roaming, and international roaming. The volatility chart here is also a Type II high volatility. Both are currently high and should be declining. We suggest considering medium term bull call spreads for the direction without the expected declining volatility risk. Alternatives seeking to benefit from the current high volatility include near term covered call sales and put sales.

Aluminum Corp. of China Ltd. (ACH) 67.79. (the price quote is correct – most unusual to have two stocks in the same group closing at the same price). ACH engages in the production and sale of alumina and primary aluminum in the People's Republic of China. This stock has quickly broken out above the recent pre-correction highs. Again the volatility chart here is a Type II high volatility. Both are currently high and should be declining. We suggest considering medium term bull call spreads for the direction without the expected declining volatility risk. Alternatives seeking to benefit from the current high volatility include near term covered call sales and put sales.

China Life Insurance Co. Ltd. (LFC) 72.93. China Life provides annuity products and life insurance to individuals and groups in China. The company offers products and services, such as individual and group life insurance, accident, and health insurance. Again we have a Type II high volatility chart. Both are currently high and should be declining. Again we suggest considering medium term bull call spreads for the direction without the expected declining volatility risk. Alternatives seeking to benefit from the current high volatility include near term covered call sales and put sales.

We think the breakout pattern we are seeing in the China stocks are probably a result of the change in the government policy allowing mainland Chinese to invest in Hong Kong listed stocks that we mentioned above. This change should have a significant and positive effect on the Hong Kong market.

Again we encourage you to let us know what you think about how we are doing and what you would like to see in futures issues. If you have questions or comments or requests just let us know. If you have some trading ideas that you would like to share with us then use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.