IVolatility Trading Digest™
Volume 7, Issue 3
February 19, 2007

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer

Better Whole Foods and Refining the Ranker


Our purpose is to offer some ideas that will help you make money using IVolatility. We will also use some other tools that are easily available with an Internet connection. Not a lot of complicated math formulas but good trade management. In addition to Volatility we use fundamental and technical analysis tools to increase the probability of success and reduce risk. We prepare a written trade plan defining why the trade is being made, what we call the "DR" (determining rationale) and the Stop/unwind, called the "SU".


In this section which we call IVOLopps™ (IVolatility Opportunities) we will focus on recommendations that should be made now, or Action Now! For many event driven opportunities volatility will be abnormal for very short periods of time so action is recommended without delay. Our assumption is the trade will be made the next day.


Our next section we call IVOLalerts™ (IVolatility Alerts). These recommendations require some additional time before being made. Often we will be waiting for confirming fundamental or technical developments before making these trades.

Current Market Volatility

For the week ending 2-16-07, Market Implied Volatilities are again lower.

IndexClose 2-9-07Close 2-16-07Change
VIX - SPX Implied11.1010.02-12%
QQV - Nasdaq 10016.0913.81-14%


In the February 5, 2007 IVolatility Trading Digest™ we recommended the sale of Whole Foods Inc., WFMI March 40 Puts FMQOH at .72.

On Feb 14 Whole Foods Market, Inc. announced that it will issue financial results for the Company's first fiscal quarter ended January 14, 2007, after the market closes on Wednesday, February 21, 2007. Following the release via the wire services, the Company will also host a conference call with financial analysts and investors at 4:00 PM Central Time / 5:00 PM Eastern Time.

As a result the IV of the March 40 Puts has risen to 51.58 while the price of the puts have declined to .46-.48. If the IV had not risen, we would have expected them to be .38-.40. Although out-of-the-money, they seem to be the ones that are being bought as a hedge against an earnings disappointment or management comments on Wednesday.

We have several choices including closing the position for a .25 gain in two weeks, all as a result of the rising stock price, hedging, using short stock or some combination of options. The simplest would be to short stock on Wednesday at a rate of 13 shares for each short put position open since our delta position is +.13 for each option.

Another possibility is to explore the opportunity to hedge and perhaps sell more of the now more expensive WFMI March 40 Puts.

Let us look and see what we find.

Opening the IVolatility Advanced Options page, we have:

Fig. 1 WFMI Mar07 and May07 Puts

Notice the circle around the IV for the March 40 puts showing 51.58%. Then take a look at the May 35 puts FMQQG with an IV of 41.02 and the May 40 puts FMQQH with an IV of only 38.09. We could buy one of these for each March 40 that we were short as a hedge.

A check of the volatility chart from the IVolatility Basic Options section encourages us to think that an IV forecast in the low 40�s is about right. See the chart below:

Fig. 1 One year WFMI Implied Volatility history

This means that there is a good chance that the March 40 puts will loose about 10% points of IV after the announcement. Since it is selling at 51.58, we can estimate the decline in the put price that will be from the decline in the IV. In the column headed Vega we see that the option�s Vega is .027 and we know that the Vega of an option is the change in theoretical value for each one percentage point change in IV. Therefore, a 10% decline would reduce the theoretical value of the option by .27. We would not expect to see the same decline in the May 35 or May 40 puts, as they seem to be at about the right IV level now.

If we buy a May 40 put for each March 40 put we are short, we will have created a Calendar Put Spread. A quick check of the delta of this proposed spread shows that it is slightly negative. The March 40 puts are -.13, see columns market Delta, while the May 40 puts are -.1795. Therefore the calculation for each spread we would be -.1795 and .1300 (we are short the negative so it is then a positive number) or -.0495, which is the difference.

While this may seem to be about right for a hedge there could be a conflict with our technical analysis showing a slight upward bias. We would prefer to be more delta neutral. The delta of the May 35 puts is -.0643, see the IVolatility Advanced Options page above. Using this put would make us slightly delta positive, but if we combined it with another March-May 40 Calendar Put Spread it would be about right while giving us the opportunity to further capitalize on the high IV for the March 40 puts.

Here are the numbers for the delta calculation:

Existing -1 Mar 40 Put (-)x(-).1300.0315-.0270
New +1 May 35 Put-.0643.0133+.0293
New -1 Mar 40 Put (-)x(-).1300.0315-.0270
New +1 May 40 Put-.1795.0300+.0612
Position Total-.0162+.0365

Now this is a better Delta Neutral position. We can benefit from the expected decline in IV of the March 40 puts while hedging away most of the price risk. Remember this is a short-term adjustment, as the expected change will come in just 4 days with Thursday�s trading.

Trade Plan

Before the close on Wednesday, for each Existing Short March 40 Put:

Buy one May 35 put FMQQG .28-.30 FV .29 IV 41.02
Sell one Mar 40 put FMQOH .46-.49 FV .47 IV 51.58
Buy one May 40 put FMQQH .92-.96 FV .94 IV 38.09

This is a short-term trade plan that converts our position form a volatility and direction trade into just a volatility trade. We will review it again next week to determine if we want to reestablish the directional bias.

The DR remains unchanged, as this is a quality company operating in the premium sector. The SU remains at 40.


Now let us turn our attention to some further refinements of selling implied volatility. The concept of selling something expensive, say options with high IV, or buying something cheap, like options with low IV is easy to understand. Just because on option is expensive does not mean that it may not become more expensive.

With stocks, considerable attention should be given to technical indicators as well as the fundamentals. Pay particular attention to the recent news releases to see if anticipated events are influencing the options price. Merger and takeover activity, expected earnings announcements, settlement of major lawsuits, restatement of financial reports, and stock buybacks are some examples.

Keeping these thoughts in mind let us search for some high IV candidates using the IVolatility Advanced Ranker (see the left column under My Services). At the first tab, Implied Volatility Index select the following �All USA, Show stocks with price above: Set to $10 (or more if you desire). Then select the fifth row down, Implied Volatility as a scaled % of IV Hi/Low range. For the IV Index Column use, Mean. For IV Term use 30, For the HV Term again use 30 (these are the default values), then for Quantity of stocks to be viewed set it at 100. Finally, for Display stocks accordingly, set it to Top ranked only. For these settings see the example below:

Fig. 3 Selection criteria for Top 100 stocks in 1-year IV range

When you press Show, the result is 100 ranked IV candidates in a scaled range, meaning those that show a 100 rank in the highlighted column 6 are at their high IV for the last 52 weeks. To illustrate here are the first seven of the top 100.

Fig. 4 Top 100 stocks in 1-year IV range

You will notice that the IV Index Last, column 2 is at the top of the range as indicated in column 5. For example, AUXL the first stock is showing 62.96 for IV Index Last, column 2 and shows a 52-week range of 62.96/42.53 in column 5. This means it is at a 52 week high.

As we mentioned at the start of this section, this does not mean they are the best sale candidates. It does mean they are the focus of options buyers and/or sellers. It does mean we need to do more work. For example, if we could find those that are high but not at the highest level in 52 weeks perhaps we could find those that are now declining from their high IV and are in the process of returning to normal levels. These would be the better candidates in terms of risk to our proposed option selling strategy.

For example, look at candidate number 43 in our search result, and this week�s top rank stock by Investors Business Daily in their weekly IBD 100. See below:

Fig. 5 SYX:NYSE (SYSTEMAX INC ) - Advanced Ranker #43

While the IV is still high it is not at a 52 week high and has begun to decline.

See the Volatility chart below which is found at the Basic Options section of IVolatility

Fig. 6 One year SYX:NYSE Implied Volatility history

As we can see both measures of volatility, both IV and HV (Historical), are declining. This would seem to offer a better chance of success.

Let us see if there are any interesting candidates. Again, refer to the Advanced Options section of IVolatility.

Look at the March 25 Put with an IV of 73.17%. See the circled number in the highlighted column.

Fig. 7 SYX:NYSE Mar07 Puts

Before we proceed, we need to do some fundamental and technical research.

Systemax, Inc. operates as a direct marketer of personal desktop computers, notebook computers, computer related products, and industrial products in North America and Europe. However, a quick review of current news articles revels that there may be some questions relating to its accounting and management of customer rebates. Could this be the reason for the high IV of the puts? If so, is this a risk we want to take?

Checking the chart of SYX, see the Stock Sentiment Analysis in the IVolatility Stock Sentiment section below:

Fig. 8 SYX:NYSE Sentiment Analysis

We conclude that the stock is in overbought territory and is likely to correct, therefore its been placed into our IVOLalerts� category pending further technical and fundamental developments.

IVolatility Trading Digest™ Disclaimer
All prices and data are based upon closing prices as of February 16, 2007. Nothing contained in this letter constitutes a recommendation to buy or sell any security. Before entering a position check to see how prices compare to those used in the recommendation, as the prices are likely to change on the next trading day. Make sure to due your fundamental and technical analysis work along with a realistic evaluation of position size before making a commitment.