« August 2008 »

IVolatility Trading Digest™

Volume 8, Issue 29
Biotech Encore

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).

Because there was another takeover announcement in the Biotech group as Bristol-Myers Squibb Co. ( BMY) 21.11 offered 60 per share for Imclone Systems Inc. (IMCL) 65.34, we are going to focus on this improving sector once again and provide a few more suggestions.

First we start with an update of the Market Review and Strategy sections and take a look at the financials. Then we close with one long idea and a Takeover File update.

Market Review

S&P 500 Index (SPX) 1260.31. Although the SPX has recovered from the July 15, 2008 bottom at 1200.44 we are looking for it to retest the low over the next few weeks. We think it is very unlikely the SPX can continue higher without first retesting the 1200 level. While another concern is the current p/e multiple of 16 and a forward p/e multiple of 15 seems hardly like the stuff of bargains that are found at market bottoms. The expected upcoming retest of 1200 will be the obvious decider.

The CBOE Volatility Index (VIX) 22.57. Now in the middle of its recent range with a slight downward bias the VIX appears to be reflecting the bounce in the SPX from the low two weeks ago. We should see the VIX turn higher once again as the SPX returns to the downside to retest the 1200 level. If you can watch the market and close the position on a intra-day basis, a long Bull Call Spread, for example, Long the Sep 27 call and Short the Sep 30 call, would make an inexpensive hedge for the retest at a cost of .35.

The US Dollar Index (DX) 73.42. The DX returned once again to successfully test the 72 level before continuing higher and is now approaching 74 once again. If it continues higher than 74.314, basis cash, that it made on June 13, 2008 it will mostly likely add to the downside pressure on oil, gas and the commodity sectors.

NYSE McClellan Summation Index. Our market breadth indicator continues upward at a pace consistent with the rebound in the equity market. With a current reading of –765.75 it has made a good recovery from the –1218.42 low made on July 16, 2008.


In a declining market environment one would expect to begin seeing stocks in the Consumer Staples sector to begin performing better on a relative basis. Along with Biotech we are now seeing improvement in selected consumer staple stocks, such as Kraft Foods Inc. (KFT) 32.04. Since Proctor & Gamble Co. (PG) 64.95, reports earnings on Tuesday it will provide a good test to see if the consumer staples relative strength can continue. The rotation out of energy and cyclical commodities is consistent with the expectations of a slowing economy. We suggest a cautious approach in general while selecting longs since the market at 15-16 times earnings is hardly at bargain basement prices considering the expected near term growth rate for the economy is very low. Since the financials have made a nice bounce on most probably short covering we are ready to suggest they be shorted once again in anticipation of the SPX retesting 1200.


More Biotech

Following the abbreviated format that we adopted last week for this sector we are going to offer some additional suggestions. Again we suggest checking the fundamentals, identifying the upward sloping trendlines to use for the SU (stop/unwind) levels and look for the next reporting date before taking a position.

First a look from an options perspective at the proposed 60 per share offer by Bristol-Myers Squibb Co. (BMY) 21.11 60 for the 83% of Imclone Systems Inc. (IMCL) 65.34, that it does not already own. With the current Implied Volatility Index Mean at 24.92 (lower than at any point for the last year) the options market is indicating that the current price of 65 is what BMY will have to pay for IMCL and there will not likely be any further increases. From an industry perspective there may be more consolidation opportunities yet to come, but it looks as if IMCL is a done deal.

Last week we were reminded of the advantage to using ETFs for this sector.

Elan Corp. Plc. (ELN) 9.93. After reporting earnings on July 24, 2008 and then closing up 1.85 to 33.75 on July 29, 2008, took a hit on Wednesday declining 14.12 on phase II study news that Alzheimer's patients did not benefit from treatment with their experimental drug bapineuzumab. Then on Friday the stock declined another 10.12 on the news on of a regulatory filing of two new cases of a serious and often deadly brain infection in multiple sclerosis patients being treated with Tysabri drug being developed with Biogen Idec Inc. (BIIB) 50.01, also down 19.75.

With losses like this the advantages of using an ETF like iShares Nasdaq Biotechnology (IBB) 88.60, are obvious as it closed up 2.69 for the week.

Keeping the risk in mind here are a few more suggested consolidation candidates that analysts have recently mentioned.

Amylin Pharmaceuticals Inc. (AMLN) 30.60. Historical Volatility 64.96.

BioMarin Pharmaceutical Inc. (BMRN) 32.08. Historical Volatility 61.79.

Gilead Sciences Inc. (GILD) 53.69. Historical Volatility 43.30.

Onyx Pharmaceuticals Inc. (ONXX) 40.03. Historical Volatility 67.05.

And one with a positive volatility spread and edge.

Momenta Pharmaceuticals Inc. (MNTA) 16.66. Historical Volatility 55.01.

Now 1.66 out-of-the-money if the stock closes below 15 on the Sep options expiration then plan to take in the stock by assignment and begin selling covered calls. Your basis in the stock would then be 13.625 and below the current support at 14.

Flaunted Financials

The chances are that the rally in the financial sector was energized in part by the new enforcement posture adopted by the SEC with respect “naked shorts” in selected financial stocks. As the brokers “bought in” the naked shorts it turned the whole sector higher. Now the Financial Select Sector SPDR (XLF) 21.63, and many of the individual financial stocks will have to retest their prior lows along with the SPX.

Anticipating a financial sector retest here is an ETF we have suggested before.

UltraShort Financials ProShares(SKF) 120.26. This ETF seeks daily results corresponding to twice the inverse of the daily performance of the Dow Jones U.S. Financials Index. The fund normally invests 80% of assets in financial instruments with characteristics that should be inverse to those of the index. The Dow Jones U.S. Financials Index is broad based and includes 286 banks, insurance companies, and investment management, mortgage companies and REITs. With a current Historical Volatility of 125.10 take a look at this idea with 75 days to expiration.

With 5 points between the strike prices defining the maximum value of the spread and with a cost of 1.55 the maximum potential gain is 3.45, but the loss is defined and limited to the 1.55 debit. We suggest this position be watched carefully because it is leveraged and moves very rapidly as indicated by the HV or 125. Be prepared to close it on a large one-day upward move.

Long Candidate

Now here is a long suggestion that is making its own fortune independent of the current equity market.

QUALCOMM Inc. (QCOM) 55.47, designs, manufactures, and markets digital wireless telecommunications products and services based on its CDMA technology.

Only July 23, 2008 QCOM announced the settlement of a long standing patent dispute with Nokia (NOK) including a 15 year royalty agreement. Now both companies could be working together to confront Research in Motion (RIMM) and Apple (AAPL).

With a current Historical Volatility of 59.42 consider this low cost synthetic alternative to a long stock position in QCOM.

We suggest using a close below 50 as the SU (Stop/unwind).

Takeover File Update

Huntsman Corp. (HUN) 13.22. Salt Lake City based HUN manufactures and markets specialty chemical products worldwide.

After the disastrous price decline as we wrote in IVolatility Trading Digest™ Volume 8, Issue 26, Right Side, dated June 30, 2008, we advised taking in the assigned stock from the short Jul 17 ½ and Jul 20 puts.

With a current Historical Volatility of 66.92 and likely declining back to 55 or so here are two call sale suggestions against the long stock.

The sale of one call makes the new position delta positive .8306, while selling two calls would make it delta positive .6612 and bring in twice the premium, or .55.

An alternative would be the sale of the September calls.

With this alternative the sale of one call makes the new position delta positive .6632, while selling two calls reduces it to .3264 and doubles the premium income to 2.050.

Another alternative that involves assuming some additional risk is to sell a covered strangle, selling both a call and a put against the long stock.

This alternative makes the position delta positive 1.0309 but it brings in 2.95 of premium and there is a good chance that both sides of the strangle will expire allowing us to do it again. If the stock goes higher our short call is covered with stock. If it goes lower we run the risk of being assigned once again if it closes below 12 ½ on the September expiration.

Declining crude oil and natural gas prices should help HUN and as long as the troubled takeover remains active and the Implied Volatilites remain high we have a good chance of recovering our initial cost.

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.


why do you like debit spreads so often

Posted by peter brereton on August 06, 2008 at 09:28 AM EDT

Peter, Thanks for asking the question about debit spreads. First we want to apologize for the delay in responding. It seems our response notification system had some problems. In general spreads offer several advantages over outright purchase or sales of options. One of the more important advantages is their ability of offset volatility and time decay risk. If we are simply long an option and the implied volatility declines the option value will decline even though the stock price is unchanged. The same is true of time decay. If the stock price remains unchanged its time value will decline each day reducing the value of the option. By using spreads we offset these two big concerns. How much and to what extent of course depends upon the number of options used in the position. While there are a number of more complicated strategies we attempt to keep it on a more basic level so we can explain it better. Why debit spreads over credit spreads? It is usually difficult to find the volatility edge in a credit spread. This means the option we are selling is cheaper in implied volatility terms than the option we are buying, thereby giving up the edge. We attempt to do just the opposite and buy an option that is cheaper in implied volatility terms and sell the one that is expensive. This is the edge we seek and it is comparable to the edge that the casino has when it sells expensive bets to gamblers. We are more often to find the edge with debit spreads and put sales. Jacktrader

Posted by Jacktrader ( on September 08, 2008 at 10:58 PM EDT

Permalink Comments [2]

IVolatility Trading DigestTM Disclaimer
IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.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 digest, as the prices are likely to change on the next trading day. Our personnel or independent contractors may own positions and/or trade in the securities mentioned. We are not compensated in any way for publishing information about companies in the digest. Make sure to due your fundamental and technical analysis homework along with a realistic evaluation of position size before considering a commitment.

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".