« December 2008 »

IVolatility Trading Digest™

Volume 8, Issue 48
More Bad News

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Last week in IVolatility Trading Digest™ Volume 8, Issue 47, Bad News, dated December 8, 2008, we noted how the equity markets ignored negative news and closed higher. This week we have an encore performance. Once again the markets shrugged off at least three important negative stories and closed higher. First JPMorgan Chase & Co’s (JPM) 30.94 CEO Jamie Dimon announced they are expecting a "terrible" fourth quarter. Then we get the Bernard Madoff Ponzi scandal, which has the potential to be the biggest fraud in Wall Street history, followed by the news of the Auto bailout plan that failed in the US Senate. With news like this, the markets should go down. Instead, they closed higher on Friday making a net gain for the week. What gives? As we suggested last week the answer maybe be that most sellers are exhausted and now large buyers are hoping to use the bad news for bargain hunting.

Two other noteworthy developments are 3-month Treasury bills now yielding .01% and the reversal in the US Dollar Index. We include more details below in the market review section, and then we have a crude oil trade update, an interesting suggestion in the crude oil tanker sector, an adjustment for the open gold trade and an idea for a closely watched upcoming earnings report.

Market Review

S&P 500 Index (SPX) 879.73. Although equities encountered serious headwinds last week they managed closed up 6.14 on Friday and 3.66 for the week. As we wrote above, with all of the negative news the market digested last week a loss was expected.

S&P 500 Index IVX 47.32. The Implied Volatility Index Mean (IVXM) declined 6.87 for the week a remarkable achievement in a week with such considerable negative news. The IVXM has been in a downtrend since December 1st and looks likely to continue lower.

US Dollar Index (DX) 83.64. DX changed direction and is now headed lower. The first sign of the turn came on November 24, 2008 when it crossed below the upward sloping trendline off the September 22, 2008 low at 75.89. The change in direction was then confirmed when it closed below the neckline (NL) of the Head & Shoulders Top on December 10, 2008. It quickly declined to the minimum measuring objective (MO) at 83 as shown in the chart below. While we expect it to continue lower there is good support around and just under 82 and then the next stop is 80. The declining dollar should support gold and some commodity prices, while crude oil and related products could be the exceptions.

TED Spread 1.91. Bloomberg’s TED spread declined 27 basis points on lower Eurodollar deposit rates indicating conditions are improving in the interbank market. The surprising demand for 3-month Treasury bills has driven the yield down to just .01% and there were reports during the week that the yield actually went negative for a brief period. The low Treasury bill rates seem to be reflecting large cash balances from liquidated stock positions, both long and short and the posting of margin requirements in the futures markets. If equities continue improving, we expect to see Treasury bill rates rate return to more normal levels.

NYSE McClellan Summation Index. Our market breadth indicator is now higher for the last three weeks with another 332.58 point gain increasing the index up to -765.98 and confirming the firmer tone we now seeing developing in the equity markets.


For the second week, the equity market closed higher on negative news and we are beginning to see a good number of stocks and ETFs forming bottoming and reversal patterns supporting the thesis that equities are starting to turn. Chances are now improving that the relentless selling has been replaced with selective buying once again. We now think the time has come to begin looking for a few long strategies.

Short Crude Oil Update

Before turning to the long suggestions, we want to look at our crude oil short positions.

United States Oil (USO) 38.10. This ETF reflects the spot price of West Texas Intermediate (WTI) light, sweet crude oil.

Based upon a one- lot position we have a credit basis in the closed combinations and spreads of $972.50. In addition, we have two open bear put spreads. The first is long Dec 50 put/short Dec 44 put from Issue 43 with a debit of 2.65, currently marked-to-market (mid prices) of 5.70. The second position from Issue 46 is long Jan 40 put/short Jan 36 put with debit cost of 1.50, currently marked-to-market (mid prices) of 2.15.

While crude oil trend continues lower, we are now somewhat more cautious ahead of the scheduled OPEC meeting in Oran, Algeria on Wednesday December 17, 2008. While most analysts are expecting a cut in production, nobody knows the quantity or the time- frame. The second reason for caution is the declining dollar and the potential for crude oil to become a dollar hedge once again.

The SU (stop/unwind) is set at a close above 45, just above the November 26, 2008 pivot at 44.60.


Nordic American Tanker Shipping Ltd. (NAT) 33.20. Hamilton, Bermuda based NAT owns and operates 12 double hull Suezmax crude oil tankers with two more on the way that have already been financed. The ships with a breakeven daily cost of $9,000 operate in the volatile spot market.

The interesting part of the story is the removal of shipping tonnage from the market to be used as storage due to the unusually large contango in the crude oil futures market. When the deferred months sell at substantial premiums to the near months and spot price, there is an opportunity to buy crude oil in the spot market and store it for future delivery at a higher price. When land storage is unavailable crude oil tankers are an alternative.

With a Historical Volatility of 84 consider this idea.

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about .62 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .13 for each point change in the stock price.

If NAT declines below 25 on the January options expiration the basis in the assigned stock would be 24.48, just .45 above the low price of 24.03 on November 21, 2008, when the Suezmax World Scale freight rate (Novo-Augusta) was WS 120 or $57,246 per day. The equivalent rate last week was $81,709 while the week before it was $99,171. With these margins, NAT could continue paying the $6.40 dividend or 19%, supporting the stock price.

SPDR Gold Shares (GLD) 80.85. The Trust holds gold and issues shares in exchange for deposits of gold.

With large trading volume and open interest the bid/ ask spreads in the options are reasonable. The current Historical Volatility of the ETF is 42.

We last suggested a bull call spread in IVolatility Trading Digest™ Volume 8, Issue 45, Bear Revival, dated November 24, 2008 when GLD was 78.85. The long Jan 80 call/short Jan 85 call was 1.70 and it now has an indicated mid-price of 1.925.

With confirmation that the US Dollar has turned down consider adjusting the bull call spread as follows:

New Suggested Adjusted Position:

Long Jan 80 call GLBAB cost 5.75 IV 49.60, mark-to-market 4.65 IV 41.52 Delta .5606
Short Jan 102 call GLDAX .60 IV 53.84 Delta -.0994
Adjusted cost basis 3.825 (1.70 original spread cost plus 2.125 adjustment debit above)
Adjusted mark-to-market 4.05 (4.65 long Jan 80 less .60 for the short Jan 102)
Adjusted position delta .4612

We suggest making the adjustment to increase the potential gain from wider strike prices and to realize the decline in implied volatility from IV 51.13 to IV 43.12 with the original short Jan 85 call replacing it with the Jan 102 call with an IV of 53.84. Such adjustments require some trading skill but are worth attempting when you find the opportunity.

The debit for the adjustment indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the debit on Monday should be about 2.05 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .28 for each point change in the stock price.

Set the SU (stop/unwind) at a close below 72 ½ and change the SU on the earlier bull call spread to reflect this new higher level.

Earnings Report

Goldman Sachs Group Inc. (GS) 67.74. Investment and now commercial bank GS will report earnings before the opening on Tuesday December 16, 2008. Taking our cue from Jamie Dimon at JP Morgan Chase & Co. we wonder about the GS estimates for a loss of 3.50 per share. In the event the actual losses are larger than expected and the market takes the stock price lower here is a suggestion to hedge the downside for those long the stock or to take a short position for those who think the earnings estimates are not realistic. With a current Historical Volatility of 126 and an Implied Volatility Index Mean of 97.49 with a long-term forecast of 75, consider this suggestion.

The debit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the debit on Monday should be about 3.56 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .30 for each point change in the stock price. Comparing the implied volatility of the long at IV 114.88 to the short at IV 140.39 this spread has a good edge. Since the earnings report will be announced before the opening on Tuesday, there is just one day to open the position.

In the event the stock trades lower the maximum value of the spread is limited to the difference between the strike prices or 10 points. Subtracting the initial debit the maximum gain could be 6.44 or 181% in the event of a large stock price decline. The maximum loss is limited and defined by the debit while the volatility and time decay risks are mostly offset.

This is a December spread and the options will expire at the end of the week so we suggest the position be closed shortly after the earnings report is released or at least by the close on Friday. If the earnings are better than expected and the stock trades higher we suggest setting a SU (stop/unwind) in the event the stock trades above 75 before the close on Friday.

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. If you would like to receive the Digest by e-mail let us know at Support@IVolatility.com.


Your statement,”…now large buyers are hoping to use the bad news for bargain hunting.” doesn’t make sense to me. If the “Bad News” wasn’t driving the prices down then how could there be a, “Bargain”? It would make more sense if you said sellers are exhausted and the bargain hunters supporting the index.

Posted by Richard Emerson on December 15, 2008 at 10:39 AM EST

Hello I can't seem to be able to find GLDAX Is it the same as GCZAX ? Thank you JGL

Posted by Jackie on December 15, 2008 at 11:01 AM EST

In your trading digest you state often adjust the postionusing position delta... What egsactly do you mean by "adjust the position" and how can this be done

Posted by Zoran Pavlic on December 15, 2008 at 10:17 PM EST

Richard, Thanks for the comment. Hopefully our comments were not too confusing. Our intention was to point out the contrarian strategy of buying on bad news in an attempt to take advantage of temporary lower prices. You are right, when the sellers are exhausted then the bargain hunters have the opportunity to begin the process of turning the index higher. For this bear market the operative word is “process” as it may take awhile. From the volatility perspective this means there could be many option opportunities. Jack

Posted by Jacktrader ( on December 17, 2008 at 02:30 AM EST

Jackie, Thanks for the comment. You are right, we do indeed mean the GCZAX the symbol for the Jan 102 GLD call. Jack

Posted by Jacktrader ( on December 17, 2008 at 02:39 AM EST

Zoran, Thanks for your question. The reason we calculate the delta for a position is to provide guidance for the next days trading. We base our numbers on the closing prices as of the prior Friday and we know the actual prices will be different on Monday. One of the differences will be the change in the value of the option or spread from the change in time value or theta. In addition, if there is a change in the price of the underlying stock or ETF then we need some way to know that our position is still maintains its relative valuation based upon the Friday analysis. For this we use the delta, or the change in the value of the option with respect to the change in the stock price. For example, if the delta is .25 and the stock is up 1 point on Monday then the value of the option and/or position should be increased by .25. If the stock price were lower by 1 point then the value of the option or position would be reduced by .25. So by adjustment, we mean up or down by an amount determined by the delta, which could also be positive or negative. Jack

Posted by Jacktrader ( on December 17, 2008 at 03:00 AM EST

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