IVolatility Trading Digest™
Volume 7, Issue 5
March 12, 2007

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

Volatility Forecasting
Daytripping to Macau


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 3-09-07, the key Market Implied Volatilities are declining

Index Close 3-02-07 Close 3-09-07 Change
VIX - SPX Implied18.6114.09-4.5%
QQV - Nasdaq 10022.1615.39-6.8%

For a better understanding of the recent changes in volatility, consider the 20-day ranges for these major market indicators.

Index High Low Range
VIX - SPX Implied20.31 (3-05-07)9.70 (2-14-07)10.61
QQV - Nasdaq 10024.00 (3-01-07)13.61 (2-16-07)10.39

Perhaps some further analysis would be useful. At the Basic Options section, you will find the chart for the VIX. If we compare the ranges of the spike in VIX volatility from last May-June, (see chart below labeled 1. & 2.) to the current period (labeled 3.& 4.) you will notice that the ranges, to date are very comparable. Last May-June the range was 9.55 and measured from the opening gap on 2-27-07 (3.) the range to date is 8.19.

Fig 1. VIX one year chart

Last May-June we experienced higher volatility for about two months. One could easily conclude that we can expect these higher levels for the next month or more.

For the near future, this translates into more volatility opportunities. However, applying some basic technical analysis definitions, specifically a lower high and lower low than the previous period, thereby defining a downtrend, we may well conclude that we can expect to see VIX volatilities below the 10% level this fall.

In the February 12, 2007 IVolatility Trading Digest™, we recommended Straddles on the Technology Select Sector SPDR, (XLK) due to the low market volatility at that time. Our recommendation stated:

This is a volatility trade with a slight negative bias. The primary objective is to benefit from an increase in market volatility over the next several weeks. If the volatility does not increase or in fact declines from current levels then the position size will need to be reduced. It may take some time for volatility to increase. Some patience may be required. The options expire in 124 days but we will not want to hold them for more than 90 days. If we do not get the desired result in this period, we will adjust the position. This can be used as hedge trade for other longs.

For the results take a look at the volatility chart below found at Basic Options.

XLK one year volatility chart

Here too the range is about 10 percentage points and approaches the highs of last May-June.

For the Record

In the February 26, 2007 IVolatility Trading Digest™, we stated that we intended to close the Whole Foods (WFMI) position and prepare a final accounting. At that time, we had an unrealized gain of $355 on a delta neutral position that experienced an unusual one-day 14% advance. Using the closing prices for February 26, 2007 the gain was reduced to $305. On February 27, 2007, the next day, the stock declined 2.30 points and continued another point and one-half lower. However, this was not our plan so we are out. In percentage terms based upon the margin required for the initial short puts, the return was 4.19% and the estimated average annual return, considering the net cost of the delta neutral conversion was 97%. Not too bad for a trade that went against us by more that 3 standard deviations in one day.


In the February 26, 2007 IVolatility Trading Digest™ we included the volatility chart of Melco PBL Entertainment (Macau) Ltd. (MPEL).

The updated chart follows:

Fig 3. MPEL one year volatility chart

The IV has begun to decline from the 57% level to about 54% and there is noticeable positive volatility spread between the HV and IV. Perhaps there are some opportunities here. We might consider selling puts or a covered call sale.

Before we look for specific options let us try to assess the risk and the reason for the well-defined positive volatility spread.

Melco PBL Entertainment (Macau) Limited, engages in the gaming and hospitality business. It develops, owns, and operates casino gaming and entertainment resort facilities in Macau, the People�s Republic of China. The company, through its principal subsidiary, Melco PBL Gaming (Macau) Limited, operates six Mocha Clubs featuring a total of approximately 1,000 electronic gaming machines or slot machines. Its Mocha Clubs offer video slot machine games and other electronic table games. It also has two casino gaming and entertainment projects under development, including the Crown Macau Hotel Casino and the City of Dreams integrated casino complex. Founded in 2003 the company is based in Central, Hong Kong. Melco PBL Entertainment (Macau) Limited is a 50/50 joint venture between Melco International Development Limited and Publishing and Broadcasting Limited in Australia.

First, a little bit of information about Macau and the developing gambling story.

Colonized by the Portuguese in the 16th century, Macau was the first European settlement in the Far East. Pursuant to an agreement signed by China and Portugal on 13 April 1987, Macau became the Macau Special Administrative Region (SAR) of China on 20 December 1999. China has promised that, under its "one country, two systems" formula, China's socialist economic system will not be practiced in Macau, and that Macau will enjoy a high degree of autonomy in all matters except foreign and defense affairs for the next 50 years.

It is located on the Southeast coast of China on the western bank of the Pearl River Delta at the mouth of the Pearl River 90 miles downstream from the city of Guangzhou and 37 miles from Hong Kong about an hour away by hydrofoil ferry.

China had awarded 132 countries with approved destination status, an official approval allowing Chinese to visit. According to the Ministry of Public Security, the most popular destinations for mainland tourists in 2006 were Hong Kong, Macau, Japan, Thailand, the Republic of Korea, Russia, the United States, Singapore, Vietnam and Malaysia.

Macau especially has benefited from the increase of Chinese tourists, as it has become the biggest gambler destination in the world, surpassing Las Vegas in dollars spent at around $8 billion USD. The city is under something of a renaissance with a huge influx of cash coming from the major Las Vegas casino operators. This year 10 additional new ferries will be connecting Hong Kong to Macau, helping accommodate the increased traffic between the two cities.

Chinese visitors tend to be daytrippers as the average visit to Macau lasts about a day, while Macau visitors manages to lose roughly twice as much as Las Vegas visitors in one-third of the time.

Las Vegas Sands and other casino operators are making significant investments based upon the premise that new high-end hotels will encourage gambles to stay longer and lose more.

Melco PBL Gaming (Macau) Limited, (MPBL) plans to be a major participant in this expansion.

MPBL is a developer, owner and operator of casino gaming and entertainment resort facilities focused exclusively on the rapidly expanding Macau market. They are one of six companies authorized by the Macau government to operate casinos.

MPEL currently has two casino projects under development and a third planned. First is the Crown Macau Hotel Casino targeted to open in the second quarter of 2007. Second, The City of Dreams casino complex phase I is expected to open in late 2008. Additional phases of The City of Dreams will open later.

Revenues to date have been from the operation of six Mocha Clubs. Total revenues for 2006 should be approximately $25 million. In the meantime, it looks as if, MPEL will lose $25-$30 million in 2006, mostly due to construction expenses on Crown Macau and City of Dreams.

The company made it debut as a public company on December 19, 2006 with an IPO that was priced at $19. On the first trading day, it reached $23.55 and has been on downslope ever since, closing at $15.96 on March 9, 2007.

Look at the chart below from the Stock Sentiment Analysis section.

Fig 4. MPEL Sentiment Analysis

Recently it appears some support may be developing in the $16 area.

The fundamentals may account for the declining price and the options pricing. At its IPO the company was valued at around $6 billion which seems expensive compare to the market capitalization of WYNN at around $9 billion, considering that MPEL will continue to report losses for the next few quarters. In addition, WYNN and the other operators in Macau, including Las Vegas Sands and MGM have their Las Vegas revenues to fall back on in the event that Macau disappoints. Further, all of the others in this market are expanding as fast as possible. Could it become overbuilt just as MPEL opens the City of Dreams? Other considerations include an untested joint- venture management structure. These could be some of the reasons the stock is under pressure.

As for the technical analysis, the support area has yet to be determined, so it is difficult to determine when buyers will enter the market for this stock.

While this is certainly an exciting growth story in the Las Vegas mold, one that has always been overbuilt and nevertheless continues to grow and seems thrive on the �build it and they will come� principal. One does wonder if and when there is a limit to growth.

Now for the options, see the Advanced Options section at IVolatility. com

Fig 5. MPEL Apr 07 ATM and OTM stikes

The April put and call options circled above look interesting, trading with an IV of 54.33 and 56.88 respectively, both higher than the average IVs for the puts and calls.

If you sold, the April 15 put at .70 you would have an effective price of the stock at 14.30 in the event it closed below 15 at expiration.

If you bought stock at 15.96 and sold the April 15 call at 1.80, you would have price protection down to 14.16.

For those that want the additional risk a combination of both would be interesting. Keep in mind the bottom has yet to be determined and the current 15 level may not hold. For this reason we have MPEL in IVOLalerts™.

We do think the opportunity is attractive enough to prepare a trade plan in the event to bottom is made before we return.


Somewhat risky buy the Macau �growth dream story�.

Trade Plan:

Using a technical indicator, such as Stochastic or Relative Strength indicator to confirm the bottom and the formation of a pivot,

At that time,

Buy 100 Shares of MPEL and sell one April 15 call NBQDC, now priced at 15.96 and 1.80 respectively. IV for the call is 56.88

Sell one April 15 put NBQPC, now priced at .70 IV 54.33

IVolatility Trading Digest™ Disclaimer
All prices and data are based upon closing prices as of March 9, 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.