Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Now is the season to begin looking for trading ideas in the sectors that have historically displayed a reoccurring seasonal pattern of rising in the spring. Last week we mentioned a few of them. In this Digest, we offer some specific candidates along with a few other ideas and once again, a suggestion for hedging overall market risk. First a brief strategy update.
Strategy For equities, the technical analysis perspective is not clear. In Digest issue 5, we offered the possibility of a developing Head & Shoulders Top pattern for the S&P 500 Index as it rises toward the 1120 area. There is a good chance it will trade in the 1090 -1120 range for some time before continuing higher to make new highs, or reversing to complete the Head & Shoulder Top with the measuring objective down at 934. The macro-economic fundamental perspective is not positive centered on concerns that the sovereign risk problem in Greece will not be solved and that it may create similar doubts about Spain with a much larger and more important economy. As of Friday, this concern was not reflected in the major equity ETFs as they were all skewed to the call side by 10-13%. For example, the call implied volatility of the SPDR (SPY) 110.74 was 18.10% while the put implied volatility was 15.92%. From a money management perspective there is a good argument to be made for a cautious stance and to take a wait and see approach. From a seasonal perspective, now is the time to be adding new positions in those specific sectors that begin rising at this time of the year. Combining the seasonal opportunity with a hedging plan for the downside market risk should be the best combination. Since the market implied volatility measured by the CBOE Volatility Index (VIX) 19.50 continued declining the implied volatilities of many individual equities are now at level that are no longer attractive to sell so with the exception of event ideas and special situations that have elevated implied volatilities, more spreads and fewer put sales are in order. We begin with a few seasonal ideas, two analyst upgrades, and then two event ideas with high-implied volatility and a market hedge suggestion.
Seasonal Ideas Crude oil, natural gas and oil service usually have a seasonal tendency. In the last few weeks, the declining three-month roll premium in the crude oil futures, called the contango, supports the view that the market is firming as the near term futures are becoming more expensive relative to the deferred futures. Here are some ideas to consider. BP plc (BP) 53.21. Long Call Spread, Historical Volatility (HV) 26.15, Implied Volatility Index Mean (IVXM) 23.71.
Petroleo Brasileiro (PBR) 42.65. Long Call Spread, HV 34.97, IVXM 33.67.
McMoRan Exploration Co. (MMR) 17.28. Short Put, HV 64.19, IVXM 60.09.
Transocean Ltd. (RIG) 79.82. Long Call Spread, HV 33.18, IVXM 29.23.
The annual iron ore price negotiations will begin soon and the big miners are expected to be asking for prices that are more closely aligned to the spot price, now at $133.10, which is more than double the $60 per ton fixed price contract level that was set for last year. Cliffs Natural Resources Inc. (CLF) 56.40. Short Put, HV 70.86, IVXM 51.60
A Synthetic Long Alternative.
Vale S.A. (VALE) 27.86. Long Call Spread, HV 44.94, IVXM 37.45
The agriculture seasonal tendency starts in March and usually extends through June. Origin Agritech Limited (SEED) 8.82. Here is an interesting stock that still has high-implied volatility. Consider this put sale idea. HV 67.28, IVXM 73.35.
Upgraded on Improving Fundamentals Here are two ideas to consider based upon recent analyst upgrades due to improving fundamentals. SanDisk Corp. (SNDK) 29.15. Long Call Spread, HV 59.39, IVXM 41.37.
Hartford Financial Services Group Inc. (HIG) 24.37. Short Put, HV 41.96, IVXM 38.78.
High IV/HV Ratios From our scanner here are three ideas with high-implied volatility relative to the current historical volatility. Kinetic Concepts Inc. (KCI) 41.92. Short Put, HV 25.25, IVXM 47.53.
Here is a put spread alternative with some downside protection.
Here are two FDA event trade ideas with currently high-implied volatility. Both of these stocks are likely make large moves and will experience large declines in implied volatility on the event date. InterMune Inc. (ITMN) 13.74. Short Put, HV 56.42, IVXM 226.85.
Here is a put spread alternative with some downside protection.
Medivation, Inc. (MDVN) 36.01. Short Put, HV 34.96, IVXM 216.70.
Here is a put spread alternative with some downside protection.
Hedging Market Risk Now we turn our attention to a hedging strategy for market risk in the event SPX goes lower and sets off the Head & Shoulders Top we mentioned in the Strategy section above. If this should occur, the implied volatility will rapidly increase so initially we will use a call spread on the volatility index. Then if the decline continues, the next phase of the plan is to add put spreads using the major index ETFs. CBOE Volatility Index (VIX) 19.50. With a current Historical Volatility of 40 and with the average between the call and put adjusted at-the-money implied volatility of 64.98, here is a long call spread suggestion to consider now while the VIX is down below 20.
Summary All of the suggestions above require some additional research and are based upon Friday’s mid prices between the bid and ask. The prices on Monday will be slightly different due to time decay and will need to be adjusted for any price change in the underlying stock or ETF. Currently the technical condition of the equity market is difficult to determine, and yet while the fundamentals are negative the market is not now indicating it is about to turn lower. Under these conditions, we suggest proceeding with seasonal and special situation trades while hedging market risk.
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In next week’s issue, we will focus on updating our market indicators and report on the progress of the potential Head & Shoulder Top formation.

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