Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

In this issue we use most of our space to updating selected previous recommendations and adding another new takeover suggestion. First we have brief updates for the open gold and crude oil suggestions. Then we have two ideas for companies that have just reported earnings. We start with our market review.

Market Review.

S&P 500 Index (SPX) 825.88. Score another weekly decline for the SPX, this time it was 6.07 points or .73%. The anticipated Elliott 5^th wave down continues developing. It may take some time to be completed, but should result in a new low below the November 21, 2008 key reversal low at 741.02. From the symmetrical triangle bearish continuation pattern that began last October, we are using 690 as the estimated measuring objective.

S&P 500 Index IVXM 38.73. The Implied Volatility Index Mean (IVXM) declined for the week with a drop of 2.33 points or about 5.7%. This is noteworthy since the SPX declined for the week. Usually we expect to see higher IVXM readings as the SPX declines.

US Dollar Index (DX) 85.83. The DX continued higher once again but its momentum slowed as it added only .25 points or .29%. Since the weekly net change in the SPX was very small the change in the DX is correspondingly quite small.

iShares Barclays 20+ Year Treasury Bond (TLT) 103.75. This ETF seeks to duplicate the price and yield performance of the long-term sector of the United States Treasury market as defined by the Barclays 20+ Year U.S. Treasury index. After trading higher on Monday TLT resumed declining as long-term Treasury bond rates continued rising.

NYSE McClellan Summation Index. Our market breadth indicator reversed course last week and added 12.44 points ending the week at 156.07 as the number of gainers just nosed out decliners on the New York Stock Exchange.

Strategy

With respect to the equities we remain cautious until the SPX retests and most likely exceeds the November 21^st low in an Elliott 5^th wave down pattern. We continue to suggest that long positions be hedged with puts, collar or spreads. We now see many issues beginning to form trading ranges providing the opportunity to consider call credit spread at the top of the ranges. We would be more cautious with the put spreads on the lower end of the ranges until we reach the final bottom of the market. Since we think implied volatilities will remain fairly high for some time this could be the time to look for out-of-the-money spread combinations such as iron condors.

As we mentioned above, long-term Treasury bond rates are rising so keep open the long Mar 110/ Mar 105 bear put spread on TLT that we first suggested in IVolatility Trading Digest™ Volume 9, Issue 2, Biotechnology Week, dated January 12, 2009 when TLT was 112.73. Since then it has declined to 103.75 confirming that we are right on this direction trade.

Gold Update

While we acknowledge gold and the gold mining shares ended the week on a strong note we remain cautious as there are still some important resistance levels to overcome before we turn more bullish. Gold and the mining company shares are one of the most respectful groups to previous resistance levels.

For the SPDR Gold Shares (GLD) 91.31 it needs to close above the September 29, 2009 high at 92 and the Comex April Gold (GC/09J) 928.40 futures contract would need to close above 938.20. Until these levels are exceeded on a closing basis we suggest keeping open the short call credit spread that we suggested in IVolatility Trading Digest™ Volume 9, Issue 4, Refinery Time, dated January 26, 2009 on Newmont Mining Corp. (NEM) 39.78. NEM reversed from the 45 resistance level as expected. In the meanwhile, we also suggest keeping the Yamana Gold, Inc. (AUY) 8.06 credit call ratio backspread open as the upside opportunity in this sector in the event gold does continue higher.

Short Crude Oil Update

United States Oil (USO) 29.22. This ETF reflects the spot price of West Texas Intermediate (WTI) light, sweet crude oil.

Once again, we see no reason to unwind the now remaining USO bear put position, which is long the April 35 put and short the April 29 put.

However, we do now suggest lowering the SU (stop/unwind) once again, this time to a close above 35 which is just above the previous January 26, 2009 high at 34.10. We are expecting crude to start rising with the spring buildup season and when it does, USO will have to close above 35 and when it does we suggest unwinding the remaining bear put spread position. We will then do a final accounting of all the USO positions when this last one is finally closed.

Takeover File Update

In IVolatility Trading Digest™ Volume 9, Issue 4, Refinery Time, dated January 26, 2009 we offered two suggestions for Wyeth (WYE) 42.67.

The first was a calendar spread and the second was a call ratio backspread. Since the rumored deal was announced over the weekend the premiums on the options declined dramatically with the opening last Monday and the suggested trades could not have been completed at anywhere near the suggested prices. Oh well, this happens from time-to-time, so now it is back to the “drawing board” as they say.

So far, this deal is being met with skepticism as the stock prices of both companies declined most all week. For WYE the decline was 1.07 or 2.45 %, while for Pfizer Inc. (PFE) 14.58 it was more dramatic at 2.87 or 16.45%. Such a large decline for the acquirer is unusual and reflects sentiment that the deal is not good for PFE, despite management’s pronouncements to the contrary. For the long run we are with PFE and here are two suggestions to consider for this deal.

The Implied Volatility Index Mean (IVXM) of the WYE options declined dramatically last week from 43.33 to 21.17. This level looks too low and will likely rise if the deal proceeds, so here is a call ratio back spread that benefits with an increase in implied volatility and with enough time to expiration for the deal to be well defined. Now the Historical Volatility reading is 42 and appears to be about right.

• Sell WYE Jul 42 ½ call WYEGV 2.925 IV 24.48 Delta -.5507
• Buy 2 WYE Jul 45 calls WYEGI 1.625 each = 3.25 IV 22.51 Delta .3980 each = .7960
  Debit .3250 Position net delta .2453

The debit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the debit Monday should be about .40. Use the position net delta shown above to adjust for any stock price change or about .25 for each point change in the stock price.

For those who may have a more bullish view or think the implied volatility will not rise from the current level here is an alternative synthetic long to consider.

• Buy WYE Jul 42 ½ call WYEGV 2.925 IV 24.48 Delta .5507
• Sell WYE Jul 42 ½ put WYESV 2.725 IV 24.37 Delta .4611
  Debit .20 Position net delta 1.0118

The debit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the debit Monday should be about the same as the time decay is offset in the spread. Use the position net delta shown above to adjust for any stock price change or about 1.01 for each point change in the stock price.

Takeover Adjustment

In IVolatility Trading Digest™ Volume 8, Issue 47, Bad News, dated December 8, 2008 we suggested selling January 70 puts on Rohm & Haas Co. (ROH) 55.19 when it was 71. Then again in IVolatility Trading Digest™ Volume 9, Issue 1, New Beginning, dated January 5, 2009, we suggested the sale of January 50 puts. At the January expiration ROH closed at 60.58 so we would have been assigned stock at 70 while the 50 puts expired worthless. Subtracting the put premiums received and commissions the basis in the stock is estimated at 62.73. With the current Historical Volatility at 89 consider making this adjustment to the now long stock position.

• Sell ROH Feb 55 call ROHBK 2.90 IV 51.87 Delta -.5370
• Sell ROH Feb 55 put ROHNK 3.025 IV 57.92 Delta .4614
  Credit 5.925 Position net delta -.0756

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about 5.525 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .08 for each point change in the stock price.

We sell the straddle and book two more premiums. The short call is covered by the long stock from the assignment, but there is risk of being assigned another 100 shares of stock in the event it keeps declining. In the meanwhile, the basis the first 100 shares is reduced by two additional premiums, now down to 57.41.

Next here is an adjustment for the Dow Chemical (DOW) 11.59, bull call spread suggestion also made in IVolatility Trading Digest™ Volume 9, Issue 1, New Beginning, dated January 5, 2009. This one was to buy the Jun 17 ½ call and the sell the Jun 20 call for a debit of .61. Here is the suggested adjustment with the current Historical Volatility at 84.

• Sell DOW Jun 15 call DOWFC 1.025 IV 76.99 Delta -.3614

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about 1.00 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .36 for each point change in the stock price.

This adjustment will result in a position net credit of about .49 and a combined new net delta of -.2705, about right for this declining stock.

New Takeover Suggestion

Coach Inc. (COH) 14.60. Coach designs and markets premium leather hand and travel bags. Currently selling at 6.7 times current and 8.4 times forward earnings with very little long-term debt, 23% profit margins and 48% return on equity. Coach is rumored to be a takeover target of the premium French marketer LVMH. With these good fundamentals this would be a smart move for LVMH. Abnormally high call volume in excess of 25,000 along with a put call ratio of less than .03 (very bullish) and riding implied volatility adds credibility to this story. With a current Historical Volatility of 69 consider this call ratio backspread idea that hopefully will still be available when trading opens Monday.

• Sell COH May 15 call COHEC 2.10 IV 71.85 Delta -.5531
• Buy 3 COH May 20 calls COHED .60 each = 1.80 IV 64.67 Delta .2364 each = .7092
  Credit .30 Position net delta .1561

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about .33 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .15 for each point change in the stock price.

Use a close below the November 21, 2008 low at 13.19 as the SU (stop/unwind).

Reported Earnings – Credit Spreads

In the current negative equity environment earnings reports that boost stock prices can be an opportunity to sell a credit call spread when the after report stock price rise stays within the recent trading range. Briefly here are two suggestions to consider in this category.

Amazon.com Inc. (AMZN) 58.82. The online retailer’s stock price was up 8.82 on Fridays’ positive earning report. With a price to earning ratio of 40 and a forward price to earnings ratio of 31 this stock is testing previous resistance at 59.89 from October 30, 2008 and appears to be in a 50-60 trading range. The Historical Volatility is 72.

• Sell AMZN Mar 60 call ZQNCL 4.725 IV 60.18 Delta -.5107
• Buy AMZN Mar 65 call ZQNOM 2.690 IV 56.88 Delta .3578
  Credit .2035 Position net delta -.1529

The estimated credit Monday should be 2.02 and use the delta to adjust for the price change. Use a close above 62 on continuing high volume as the SU (stop/unwind).

General Dynamics Corp. (GD) 56.73. This defense contractor reported good earning last Wednesday and the stock immediately traded lower on Thursday after meeting resistance from the January 6, 2009 high at 61.46. The trading range appears to be 50-60 and it is now retreating from the upper end of that range. The Historical Volatility is 44.

• Sell GD Mar 60 call GDCL 1.75 IV 35.63 Delta -.3627
• Buy GD mar 65 call GDCM .50 IV 32.95 Delta .1477
  Credit .1225 Position net delta -.2150

The estimated credit Monday should be 1.19 and use the delta to adjust for the price change. Use a close above the high of 63.86 on October 30. 2008 as the SU (stop/unwind).

Away Next Week

Since we will be relocating our office next week and it may take some time to get everything up and running there will not be a Digest issue for the week of February 9, 2009. We plan to resume again on February 16, 2009.

Previous Issues and 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. 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 for us to take a look at a specific stock or ETF just 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.

IVolatility.com | Account Services | Services & Tools | Forum | Overview | IVolatility Blog | FAQ | Awards | Other Financial Resources | Search

2006 Copyright IVolatility.com All rights reserved. Privacy Statement, Disclaimer, Security