« October 2009 »

IVolatility Trading Digest™

Volume 9, Issue 42
Dollar Tumble

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Dollar Tumble

It has been a while since we have looked at the dollar in some detail so in this issue we bring up to date our long-term dollar chart and offer some comments and suggestions. Then we update a previous portfolio suggestion and offer a plan for the copper breakout and two earnings report strategy alternatives. We start by reviewing our market indicators.

Market Review

S&P 500 Index (SPX) 1079.60. Although the SPX declined last week by 8.08 points or -.7% it remains above the active upward sloping trendline from the July correction low at 872.81. While maintaining our minimum upside measuring objective at 1233.29, from the large Head & Shoulders bottom explained in Digest issue 36, there is a near term concern about the current test of support at 1080.15. We are experiencing the expected resistance at 1100, but if the support at 1080.15 fails then it will most likely decline and test the trend line, now about 1060. Monday’s closing price should provide the answer.

E-mini S&P 500 Future (ESZ9) 1077.00. For the week the December E-mini future contract was 5.25 points or .49% lower. With three days volume in excess of 2 million contracts, open interest Thursday through Thursday increased 79,420 contracts. For the bull market to continue the E-mini needs increasing volume and increasing open interest as it advances. So far, it is still on plan.

S&P 500 Index Implied Volatility (IVXM). Our Implied Volatility Index Mean was higher by .64 at 20.00 while the VIX increased by .84 to 22.27. At 23.84, the VIX 20-day moving average remains above the current VIX close.

The risk premium measures declined once again reducing the cost of using the VIX for portfolio insurance. The VIX November futures over cash premium declined 10.07% to 7.99% while December declined 2.52% to 14.28% followed with a January decline of 7.64% ending at 17.42.

The implied volatility of the VIX call options also declined with the November 22 ½ calls lower by a substantial 25.17 at 120.59, the November 25 calls were 14.61 lower at 111.99 followed by the December 25 calls 11.84 lower at 105.82. Since the VIX declined as low as 20.10 on Wednesday, the premiums followed it to lower levels.

US Dollar Index (DX) 75.47. DX continued lower last week declining another .13 as the Euro currency traded just above 150. DX now appears to be oversold so we should be expecting a bounce at any time. In the strategy section below, we have more DX observations and comments.

iShares Barclays 20+ Year Treasury Bond (TLT) 94.95. Long Treasury bonds also continued lower declining another .50 points or .5%. The declining dollar is no doubt an important part of the explanation of lower long bond prices.

NYSE McClellan Summation Index 1032.90.  Our market breadth index declined 121.93 points or 10.6% as fewer stocks increased adding to the concern of a developing divergence. From the perspective of this indicator more issues need to participate in the advance or the major indexes will face difficulty continuing higher. This developing divergence is important enough to rate one of our caution flags. flag

Baltic Capesize Index (BCI) 4842. With another sizable increase of 781 points or 19.2%, it is now hard to deny the improvement in dry-bulk shipping rates. In addition, there was even an improvement in the VLCC crude oil tanker rates as World Scale rose 5 points improving the rate by $6,919 per day, to $28,909 on one route. Better VLCC tanker rates are now beginning to confirm higher crude oil prices.


We continue our focus on the US Dollar Index by looking at a longer-term chart for some clues about what to expect, since DX appears to be oversold having declined too far too fast.

US Dollar Index

In addition to identifying possible support and resistance areas, technical analysts will often look for symmetrical patterns. For example in the fall of 2007, the Dollar Index was declining as it is now. Upon reaching 76 in late October 2007, it traded along the 76 support level until finally declining to 74.48 in mid November and then turned higher and traded up to 77.85 by December 17, 2007. See the area labeled A in the chart above. By February 2008 it was headed lower once again finally reaching support at 72 before going into a 72 -74 range that lasted until July 2008. See B in the chart above. From a fundamental perspective, dollars are often repatriated at year- end for financial statement and other administrative purposes. On the assumption that the Dollar Index is oversold and due for a bounce, the technical and fundamental influences suggest it may begin soon. If the declining dollar has been a major factor in the rise in commodities and crude oil and even equities, we may be near a meaningful correction if DX turns higher. In addition, crude oil is due for a normal seasonal decline. We suggest continuing focus on the Dollar Index or the Euro.

Portfolio Adjustment

We are constantly reminded about the importance of selecting the appropriate time frame when implementing option strategies. In IVolatility Trading Digest™ Volume 9, Issue 40, Quarterly Report Mania, dated October 12, 2009 we suggested a bullish call ratio backspread for iShares Russell 2000 Index (IWM) now 60.06 when it was 61.42.

The position was short 1 November 61 call and long 2 November 65 calls. If the current uptrend had continued, we would be OK but we did not allow for the possibility of a correction and since we are long one extra call this position has time decay working against it at an increasing rate. More attention should have been given to the Historical Volatility of the index at 21.58 when established and now somewhat lower at 21.51. Using our probability calculator and the Historical Volatility of 21.51, we calculated it has only a 16.58% or 1 chance in 6 of reaching 65 by the November expiration.

If the position is closed now based upon the Friday prices on we could book a small gain of about $3.
The alternative is to buy back the short Nov 61 call and sell 1 Nov 65 call while keeping the other long Nov 65 call. If the odds had been somewhat better would have chosen the alternative. However, since the odds are quite low, we elected to close it. Here is the adjustment trade as a spread order to close the position.


The mid price for this spread on Friday was a debit (Dr) of .885 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .89 as shown above in the “E Price” column. Note on line two we are selling 2 Nov 65 calls and the prices and Greeks shown are for both calls. Use the deltas for each leg to adjust for any change in price of the underlying ETF or use the net spread delta for spread orders.


Copper Break Out

After four attempts beginning in early August, copper has broken out above $3 per pound. Although chances are the dollar will correct reducing copper prices once again, this suggestion is based upon the breakout and the strength of the Baltic Capsize Index.

Southern Copper Corp. (PCU) 35.48. PCU operates the Toquepala and Cuajone copper mines in the Andes Mountains, southeast of the city of Lima, Peru. In addition, they operate a smelter and refinery west of the Toquepala and Cuajone mines in the coastal city of Ilo, Peru. With a production cost of just .34 per pound and a copper market price now in excess of $3 per pound, we think this company represents good value.

With a current Historical Volatility of 35.39, consider this suggestion for the sale of 2 puts.


The mid price for the put sale on Friday was a credit (Cr) of .95 for each put as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .91 each as shown above in the “E Price” column. The other “Greeks” are also based upon Friday numbers, before the position is established, and will reverse when the put is sold. Use the delta as shown above to adjust for any change in the stock price.

Since we are anticipating a Dollar Index correction we suggest using a close below the support at 31.83 as the SU (stop/unwind). The alternative is to take the stock by assignment in the event it is below 30 at the January expiration. We would then sell calls against our long stock.

Earnings Reports

We are now beginning to see the stock prices of some companies sell off on earnings reports even when they are better than expected. We may be returning to “buy the rumor and sell the news.” If so, one strategy to use is to wait for the report and then enter the order. The implied volatility of the options will have most likely declined so vertical spreads would be one suitable strategy.

Starwood Hotels & Resorts Worldwide Inc. (HOT) 33.00. HOT is in the hotel business with brand names including Sheraton, Westin, St. Regis/Luxury Collection, W and Four Points. They reported earnings of .14 last Thursday while the estimates were for .10 and the stock declined on Friday closing .63 lower however, it had risen from 30 the past two weeks.

In a well-defined uptrend, this is also a trend continuation trade. The current Historical Volatility is 47.16 and the put call ratio is bearish at 1.8.


The mid price for this spread on Friday was a debit (Dr) of .85 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .83 as shown above in the “E Price” column. Use the deltas for each leg to adjust for any change in the price of the stock or use the net spread delta for spread orders.

Use a close below the last pivot at 30 as the SU (stop/unwind).

Alternative Strategy

Another earning report alternative is to sell puts on companies that we would also want the buy at a defined price level. This suggestion is to sell the puts before the earning are announced while the implied volatility is still higher than normal.

ValueClick Inc. (VCLK) 12.85. This online advertising company is scheduled to report earnings Tuesday after the close, estimates are for .14 per share. When they reported 2Q earnings of .17 per share the estimates were for .14. After rising to near 14 per share on takeover chatter, it is now declining into the earnings report. With a current Historical Volatility of 39.90 and a put call ratio of less than .3 consider this put sale.


The mid price for this put sale on Friday was a credit (Cr) of .55 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .51as shown above in the “E Price” column. The other “Greeks” are also based upon Friday numbers, before the position is established, and will reverse when the put is sold. Use the delta as shown above to adjust for any change in the stock price.

This stock has good support at 12 so in the event it closes below 12 ½ on the November expiration we plan to take in the stock by assignment and then sell calls against the long stock since there is takeover chatter the implied volatility will most likely remain high making call sales attractive.

Visit us on twitter for more ideas from our scanners and portfolio updates, including positions closed or unwound during the week. 

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In next week’s issue, we continue the search for more earnings related suggestions.

Previous Issues and Reader Response Request

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.



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".