« October 2010 »

IVolatility Trading Digest™

Volume 10, Issue 41
Gold & Earnings

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Gold & Earnings

This will be the second week the financial news is likely to be focused on gold and earnings reports. Gold sold off in anticipation of a possible announcement coming from the G20 meeting of financial ministers in South Korea over the weekend. In the meanwhile, many more earnings reports are due to be released this week and they are surely going to create news and opportunities. We have another silver suggestion as a gold proxy and then several earnings report ideas from a volatility perspective. First, a brief strategy update.



Last week's trend continuation suggestion missed the precious metals sell off that was most likely created by apprehension about an announcement coming from the G20 finance ministers meeting. Another explanation could be profit taking after several weeks on gains. If gold and silver quickly rebound then it will have been just a temporary correction, if however, the reason was profit taking,  they will most likely continue somewhat lower before finding support. 

The S&P 500 Index and the emerging markets look like they will continue higher until the S&P 500 Index approaches its April high at 1219.80, although some signs of divergence are beginning to appear, such as the now lagging advance-decline line.

Now that the October VIX futures have expired the day-weighted front month futures premium over cash declined from last week's extremely high reading of 25.08% to a more modest 14.53%, indicating less hedging activity at the current level. 

For the next two weeks, earnings reports will continue to be an important driver of equity market activity and since the S&P 500 Index is not yet at resistance, the market bias continues to be to the upside even though some individual issues are selling off after they report earnings.



Although the precious metals market is focused mostly on gold, silver offers an attractive alternative as it is now moving with gold, but offers a lower entry price.

If last week was the beginning of a profit taking correction then this suggestion is premature and should be delayed until there is evidence that gold and silver have found support. Since it is also possible that the correction has been about a possible announcement coming over the weekend from the G20 ministers meeting, having a plan ready to go in the event they rebound quickly is a good strategy. Here is one idea.

Silver Wheaton Corp. (SLW) 26.22.

With a current Historical Volatility of 36.29 and an Implied Volatility Index Mean of 46.43 for an IV/HV ratio of 1.28 and a bullish put-call ratio of .3, consider this short put/ long call spread combination.

Silver Wheaton Corp.


As a conditional trade plan both gold and silver will need to rebound quickly, otherwise the plan should be delayed until there is evidence of support. If implemented now use a close back below 24 as the SU (stop/unwind).


Rare Earth Elements

While in the materials category, companies in this sector are being driven upward by supply concerns due to export restrictions in China.

Here are two companies in this group.

Rare Element Resources Ltd. (REE) 10.11

The current Historical Volatility is 152.15 and the Implied Volatility Index Mean is 132.11 for an IV/HV ratio of .87 in a pattern we call a Type II volatility pattern, a ratio of less than one when both are abnormally high and likely to decline. The put call ratio is at the bearish level of .7, mostly likely due to hedging after a quick move to 13.71 on October 20, 2010. Consider these two put sales as long alternatives.


Rare Element Resources Ltd.


Use a close back below 8 as the SU (stop/unwind). A more realistic alternative is to take the stock by assignment in the event it closes below 7.5 at the November and/or December expirations and then sell calls as the implied volatility will likely remain at attractive levels for some time. 

Molycorp, Inc. (MCP) 31.69.

Not surprisingly MCP also has a Type II volatility pattern with a current Historical Volatility of 81.64 and an Implied Volatility Index Mean of 70.65 for an IV/HV ratio of .87, however there is less put buying evident as the put call ratio is a more favorable .45. Here is another put sale idea to evaluate.

Molycorp, Inc.


Use a close below the last pivot at about 26 as the SU (stop/unwind). Alternatively be prepared to receive the stock by assignment in the event it closes below 28 at the November expiration.

Quarterly Earnings

With most of the important quarterly earnings reports yet to be released, here are some ideas.

Avon Products Inc. (AVP) 34.43.

Avon is due to report earnings on Thursday before the opening. The consensus estimate is for .47 compared to last year's .42. Since the near term implied volatility has been increasing going into the earnings report date, it is selected as our Best Calendar Spread on Friday.

The current Historical Volatility is 28.03 while the Implied Volatility Index Mean is 39.71 for an IV/HV ratio of 1.42 and a bullish put-call ratio of .3. Here is a slightly modified version of the calendar spread suggested Friday on our home page.


Avon Products Inc.


As an alternative, take look at this put sale.


Avon Products Inc.


Use a close back below 33 as The SU (stop/unwind) or be prepared to take the stock by assignment in the event it disappoints and closes below 32 at the November expiration.

BMC Software Inc. (BMC) 44.22.

BMC is scheduled to report Thursday after the close with the consensus estimate at .70 compared to .66 in the same quarter last year.

Near the upper end of the 52 week volatility range, the current Historical Volatility is 26.51 with an Implied Volatility Index Mean of 48.99 for an IV/HV ratio of 1.85 and a moderately bearish put-call ratio of .7 indicating hedging activity has been pushing the IV higher.

With a fairly high IV/HV ratio a straddle or strangle might be considered, but since the company was mentioned as a potential deal candidate by Citi in an October 13 Barron's article there is too much upside risk in the event a deal should be announced. As an alternative, consider this short put/diagonal long call spread idea.


BMC Software Inc.


Be prepared to take the stock by assignment in the event it disappoints and closes below 41 at the November expiration. While the implied volatility of the short options will decline, there should still be some time value in the long December call.


More Quarterly Earnings Report Ideas

Below are some more ideas for companies schedule to report this week. With IV/HV ratios greater that one, they reflect elevated levels of implied volatility relative to historical volatility. Those with implied volatility greater than 40 make attractive put sale candidates especially when the put call ratios are below .7.


Quarterly Earnings Report Ideas


Column Headings

Sym= Symbol
Last= Friday's closing price
Report= Day earnings report expected
IVXM= 30 day Implied Volatility Index Mean
IV/HV= Implied Volatility to Historical Volatility ratio
Put Call= Friday's put volume divided by call volume

All of the suggestions above are based upon last Friday's closing prices using the mid price between the bid and ask. On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.



It is not yet clear if last week's precious metals decline was related to the G20 finance ministers meeting or if it was profit taking. The next few days should provide the answer. In the meanwhile, equities look to continue going modestly higher as more earnings reports are released.



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In next week's issue, we should have a conclusion about the precious metals correction along with a review of our market indicators.


Gold & Earnings


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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".