IVolatility Trading Digest™
Volume 7, Issue 6
March 19, 2007

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

Volatility Forecast Update
Going 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

The key Market Implied Volatilities for the week were on a roller coaster ride with large increases on Tuesday followed by declines on Wednesday and Thursday only to turn higher again on Friday. Options expiration week no doubt played a part in the activity.

Index Close 3-09-07 Close 3-16-07 Change
VIX - SPX Implied14.0916.79+19.2%
QQV - Nasdaq 100 (AMEX)15.3917.50+13.7%

The intra-day high for the VIX expanded on Wednesday reaching 21.25% surpassing its recent high of 20.31%. This would be of concern if the other key volatilities followed the same pattern, but their highs Wednesday did not exceed their most recent highs. See the table below.

Index Prior Recent High This Week High
VIX - SPX Implied20.31 (3-05-07)21.25 (3-14-07)
QQV - Nasdaq 100 (AMEX)24.00 (3-01-07)21.87 (3-14-07)
VXO - OEX21.70 (2-27-07)20.15 (3-14-07)
QQV - Nasdaq 100 (CBOE)25.28 (3-05-07) 23.47 (3-14-07)

If this pattern continues and we don�t see higher intra-day highs, it would seem to confirm that the momentum of this volatility event is beginning to wane. The VIX chart below can be found at the Basic Options Section. We have added the comment comparing the highs.

Fig 1. VIX 1 year chart

Volatility Forecast

So far, the data seems to confirm the conclusion we reached last week that we will see somewhat higher but downward trending volatilities for the next few months with lower volatilities levels later in the year.

What does all of this mean from an options strategy prospective?


Over the next, few months look for opportunities to sell options with high implied volatility while remembering to consider Vega, the options sensitivity to changes in volatility. Keep in mind that options further from expiration have a higher Vega. If we are expecting lower levels of volatility in the future, we will gain the most from the decline in volatility by selling options that are further out in time. Vega is measuring the amount of option price change for a one-point increase or decrease in volatility. Therefore, if we are expecting decline volatility larger Vegas are better.

With the S&P 500 SPDR, symbol SPY let�s explore this a bit further. The SPY volatility chart from Basic Options below, with our added notation, shows the current IV levels and a forecasted lower level later this year. Remember the Index Value shown is an average for the strike prices. Each strike price has its own IV value.

Fig 2. SPY Implied Volatility Index

By looking at the price chart of the SPY below, found at the Stock Sentiment Analysis Section, we could well conclude that the 130 level is an area of support that is likely to turn the index higher.

Fig 3. SPY Sentiment Analysis

Using the 130 SPY Puts compare the Vegas found at the Advance Options Section.

Fig 4. SPY 130 Puts

This confirms that the options series further out in time have higher Vega values. Compare the May Vega of .1553 to December at .3922. Also, notice that the May IV is 19.36 while December�s is 16.76. We will need to balance the higher Vega with this skew in volatility pricing. First let�s make an estimate of the time required for the volatility to return to a downward sloping pattern. A look the VIX and SPY volatility charts above would suggest that we need three months to resume to downtrend. Using this estimate would seem to almost eliminate the May 130 Puts. We may get the direction right in this time frame but we may not see the decline in IV that we are seeking. June or September would be better choices.


We should prepare a trade plan to be ready when we see the SPY is making a turn to the upside. Based upon recent trading patterns it looks as if it may be a month or more away. Keep in mind turning this index higher will be like turning an oil tanker - it may take some time. A low with a retest a month or so later thereby creating a double bottom pattern would be good confirmation.

We can set the parameters of the position and then update the data confirming the IV and Vega relationships at that time.

DR. One of the leading major market indexes reflecting the S&P 500 Index with one-tenth of the S&P value. When the S&P turns higher the SPY will follow. Using the SPY allows us to create positions with less margin than using the S&P Index. This will be a put volatility trade with direction criteria. We will sell the puts when there is a good probability that the direction has turned up again.

Trade Plan: Using a technical indicator, such as Stochastic or Relative Strength to confirm the bottom and the formation of a pivot with a double bottom or another bottoming pattern,

At that time � not before,

Sell the SPY Sept 130 Put SFBUZ now 2.55- 2.70 FV 2.625 IV 17.20


In Volume 7, Issue 5 of IVolatility Trading Digest™ we suggested the preparation of a trade plan for a trip to Macau with Melco PBL Gaming (Macau) Ltd. If you were watching the trading during the week, you may have entered Thursday or Friday. If not, this is the time. First, some updated information:

It has been announced that The Crown Macau is scheduled to open to the public on May 9, 2007 with a grand opening event scheduled for May 12, 2007. Of course, this means their first quarter report ending March 31, 2007 will show a continuing loss and perhaps an even larger loss than previously expected as they have also advised that they will be facing a $71 million or a 14% cost over run on the project. Some portion of this will likely be reflected in the March quarter, which has probably already been discounted in the stock price.

The Crown Macau with a 36-story tower, 183,000 Square feet of gaming space, will have 220 gaming tables and more than 500 gaming machines.

We have also discovered that Melco will not be regulated by Las Vegas standards and thereby perhaps giving it an advantage over Las Vegas Sands and Wynn. For example, no background checks on the high rollers betting more that $10,000. It seems likely that The Crown Macau will become more attractive to some of the high rollers when compared to the Las Vegas casinos currently operating in Macau. In addition, The Crown Macau will be offering credit while the US based casino operators have not been offering credit to their players. These could be important competitive advantages and could lead to a higher average win-per-table-per-day compared to Las Vegas Sands and Wynn Macau.

Remember when Las Vegas Sands opened in Macau, May 2004. With an original cost of $265 million, it was generating profits of $30 million a month within a year on 300 table games and 600 slot machines. Later they expanded to 630 table games and 1,100 slots after a total investment of $400 million. Since it has been reported they have earned twice their total investment in just two years.

It would be a significant accomplishment if Melco PBL Entertainment (Macau) Ltd. earns a greater return on investment than Las Vegas Sands. Currently the market is focused on the announcement of the $14 million cost over run and next quarter�s lower earnings numbers.

Looking at the volatility numbers, we see a Positive Volatility Spread with IV above HV while both are starting to decline.

Fig 5. MPEL Implied and Realized Volatility

The price chart follows:

Fig 6. MPEL Sentiment Analysis

While the Relative Strength indicator is not convincing the pattern of the volatility chart combined with a Stochastic Buy signal from an oversold level, leads us to conclude that chances are we may have defined the bottom in MPEL. We have a pivot at the 14.12 level marking a well-defined stop.

Here are the options:

Fig 7. MPEL Advanced Options page

Here is the revised and updated trade plan:

DR: "Built it and they will come" growth model that has been successful in Las Vegas for many years is off to a promising start in Macau. There is a chance that MPEL could prove to be more profitable in Macau than the Las Vegas casino operators.

Action Now!

Buy 100 shares of MPEL at 15.51

Sell one April 17.5 call NBQDC .40-.50 FV .45 IV 56.40

Sell one April 15 put NBQPC .75-.95 FV .85 IV 58.58

The delta count is +109.69 (100 for the stock, less 28.67 for the short call, plus 38.35 for the short put, see the delta numbers circled above).

SU We have price risk so we need to define the stop and/ or unwind level at a close below the last pivot of 14.12. We will use 14 as our SU.

Risk to the SU level at 14 is .21. (15.51 stock price less .45 call premium and .85 put premium = 14.21) The alternative is to take the stock that would be assigned with a close below 15 at expiration and then sell calls against the long stock.

This is not a lot of risk for a "Built it and they will come" growth opportunity and a piece of what could prove to be a very profitable business.

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