Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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 2-23-07, Market Implied Volatilities are somewhat higher but still in a low range.
While we do not intend to review all of our previous recommendations we believe our experience with Whole Foods Market, Inc. WFMI deserves special attention due to the rapid manner that developments unfolded and the lessons we may learn.
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.
As a result, in the February 19, 2007 IVolatility Trading Digest™ we recommended a delta neutral position as the IV of our previously recommended short March 40 puts continued to rise.
Here is the summary of the put prices on 2-21-07 at the close but just before the scheduled earning announcement.
After the close of trading, the quarterly earnings were announced to be .38, while the average expectation was .41, but the earnings news was completely overwhelmed by the announcement that they had agreed to buy Wild Oats Market Inc. for about $565 million. Normally arbitrageurs will sell the stock of the acquirer and buy the stock of the acquired company. The usual result is a small price decline in the acquirer’s stock. Not in this time. Both stocks rose - quite unusual.
In fact, Whole Foods was the percent leader on Wednesday February 22, 2007. While we were delighted that we had picked a stock that went up in value, we knew that a 14% one-day price move would not be very beneficial to out delta neutral position.
And here are the prices at Friday’s close.
Now look at the price and implied volatility changes. See the before and after prices circled above in red.
After a net price increase of $4.77 the Mar 40 puts that we are short have gone from .51 to .03 as the IV declined from 54.17% to 32.49%. This decline in IV was what we had expected and was the primary reason we decided to sell these puts.
On the long side, the May 35 puts have gone from .30 to .14 while their IV increased from 40.79% to 43.89%. While the long May 40 puts have gone from 1.00 to .375 their IV increased from 37.89% to 38.38%.
Using Friday’s closing prices let us see where we are now.
(10 lot position)
February 5, 2007 Sold 10 Mar 40 puts to open at .72 each, equals $720, less commission of 7.50 (at .75 per contract), net proceeds $712.50 February 23, 2007 mark-to-market (Buy) 10 March 40 puts to close at .035 each, equals $35, plus commission of $7.50, total $42.50. Unrealized gain $670.
February 20, 2007 Bought 10 May 35 puts to open for .29 each, equals $290, plus commission of $7.50, total $297.50. February 23, mark-to-market (Sell) 10 May 35 puts to close at .135 each, equals $135, less commission of 7.50, total $127.50. Unrealized loss $170.
February 20, 2007 Sold another 10 Mar 40 puts to open for .47 each, equals $470, less commission of $7.50, net proceeds $462.50. February 23, 2007, mark-to-market (Buy) 10 Mar 40 puts to close at .035 each, equals $35, plus commission of $7.50, total $42.50. Unrealized gain $420.
February 20, 2007 Bought 10 May 40 puts to open for .94 each, equals $940, plus commission of $7.50, totals $947.50. February 23, 2007 mark to market (Sell) 10 May 40 puts to close at .375 each, equals $375, plus commission of $7.50, total $382.50. Unrealized loss $565.
Mark-to market summary including commissions, unrealized $355 gain.
Now what should we do? Since the abnormal volatility that attracted us to this put option has declined to our forecasted level, which was the reason we initiated this trade, the DR has changed and it is time to close the trade. While we have accomplished our volatility trade, we are somewhat disappointed by the overall result. Our delta neutral position was hurt by the one day 14% move in the stock. This is the risk of delta neutral positions, but we had a good reason to convert to delta neutrality. It may well be possible to improve upon these results, as the probability is that the stock will now correct somewhat further from its abnormal upside move. However, we will close the position on Monday February 26, 2007 and then prepare a final summary including return on investment calculations in the next IVolatility Trading Digest™.
Buy 20 Mar 40 puts FMQOH to close .03-.04 FV .035 IV 32.69
As the earnings announcement date approached and the IV of the Mar 40 puts continued to increase, they were giving us a signal that buyers of puts were willing to pay more for the protection. We now know why the put buyers were willing to pay more. Normally the price of the acquirer’s stock declines. The put buyers had good reason to bid up the prices. At the same time we had good reason to convert our somewhat delta positive short put position into a delta neutral position. Although we incurred a one-day move in excess of 3 standard deviations, in this case to the upside, our delta neutral position remained profitable. Our initial plan was good and we had good reason to adjust.
In the February 12, 2007 IVolatility Trading Digest™ we recommended the purchase of 5 long XLK straddles. This is a hedge position against rising market implied volatility. The plan called for selling one straddle for each day the QQV closed below 14. On February 16, 2007 it closed at 13.81 and according to the plan, the position was reduced by one straddle on February 20, 2007 the next trading day.
In last week’s edition of IVolatility Trading Digest™ we suggested that Systemax Inc. (SYX) should be added to the alerts. Here is an update of the volatility chart. Both the IV and Historical Volatility are declining.
The next two have less volume and therefore require some additional caution.
All of the above have positive Implied Volatility relative Historical Volatility and are provided here as suggestions for further research. Do your fundamental and technical homework before considering them as possible trades as volatility is only one of several considerations you must make.
In future editions of IVolatility Trading Digest™ we are planning to offer some suggested categories for the volatility patterns.
IVolatility Trading Digest™ Disclaimer
All prices and data are based upon closing prices as of February 23, 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.
IVolatility Trading Digest™ Disclaimer All prices and data are based upon closing prices as of February 23, 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.