« July 2011 »

IVolatility Trading Digest™

Volume 11, Issue 30
No Deal - Trader's Delight

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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No Deal – Trader's DelightThe news on Friday afternoon that there was no deal to raise the debt ceiling is likely to be received very negatively by market participants at the opening on Monday. After turning higher last Tuesday on growing optimism a deal was near the news that came after the markets were closed on Friday should reverse all of last week's gains and then some unless the politicians are able to pull a rabbit out of the hat before the markets open on Monday. While we have a strategy update and several trading ideas, they are all conditional on the equity market finding some stability after the expected sell off on Monday if there is no deal.



StrategyUntil the S&P 500 Index (SPX) 1345.02 breaks out above 1356.48 to the upside or declines below the June 16 low of 1258.07 we are assuming a trading range and suggest using suitable strategies including special situations while reducing or hedging overall market risk whenever possible.

Interestingly as the E-mini S&P 500 September futures contract (ESU1) 1341, rose 21.25 points last Thursday the open interest declined by 17,122 contracts. Expanding open interest is needed to keep the trend going and since the longs were selling as the shorts were covering, the upside momentum came to a halt as further evidenced by very light volume on Friday.

At the close on Friday our day-weighted VIX Futures premium over cash was 5.58%, still bullish, but less than the week before at 3.41%. Readings above 20% are generally a good indication of increased professional hedging in anticipation of an immediate decline while negative readings suggests complacency about protecting long stock positions by buying VIX futures contracts. Low and especially negative readings in the past have been good leading indicators for short-term market advances.


In the News

News Corp. (NWSA) 16.42. Rupert Murdoch's News Corporation operates a worldwide-diversified media enterprise.  

Normally in the 35 range, the current Historical Volatility is 42.72, , while the Implied Volatility Index Mean is 40.05, down from last week at 43.73, the longer average is in the 25-30 range and it now appears to be headed back down into the normal range. The IV/HV ratio is .94 while the put-call ratio at .7 is on the bearish line. Friday's option volume was 3,274 contracts compared to the 5-day average volume of 36,470 contracts.

Here is a put sale idea for the continuing decline in implied volatility.



Unless you may want to establish a long stock position use a close back below the last pivot at 15 as the SU (stop/unwind).


Top of the Range

Here is an idea from the top of the 52-week implied volatility range.

InterDigital, Inc. (IDCC) 72.96. The company designs and developments digital wireless technology and has created an extensive patent portfolio. The stock price is up from 41.51 last Monday on speculation they were considering the sale of patents.

While the current Historical Volatility is 113.07, the normal range is between 40 and 60. The Implied Volatility Index Mean is 85.44, up from 60.87 in the last week. At the top of its 52-week range, the implied volatility has not yet started to decline back into the normal 60 range. The IV/HV ratio is .76 and the put-call ratio at .4 is bullish. Friday's option volume was 32,416 contracts compared to the 5-day average of 44,310 contracts.

On the presumption that the implied volatility will start declining here is a put sale to consider.



This put allows a lot of room for the stock to decline before it is in the money, but be prepared for a possible rapid decline. If it is in-the-money at expiration, we suggest taking the stock by assignment and then selling calls against the long stock position.


Tech Time

While many advise avoiding the tech sector until September, some of the stocks are interesting now having experienced sharp declines in the last few months. This one is ranked number one in our IV/HV ratio scan this week.

Akamai Technologies Inc. (AKAM) 30.37. The company provides services for accelerating and improving the delivery of content and applications over the Internet.

Having made what appears to be a double bottom it turned higher on Friday as the volume expanded. The current Historical Volatility is 27.24 with an Implied Volatility Index Mean of 49.38, up from 48.30 last week, the IV/HV ratio is an attractive 1.81 and the put-call ratio at .28 is bullish. The option volume last Friday was 17,572 contracts compared to the 5-day average of 12,770 contracts.

Here is an interesting put sale as proxy long position.



With good volatility edge we suggest using a close back below, the last pivot at 29 as the SU (stop/unwind). Alternatively, if the stock is below 29 at the August expiration take it by assignment and sell calls against the long stock position.

NVIDIA Corporation (NVDA) 15.00. NVDA provides high performance computing, and mobile computing solutions for interactive graphics on various devices ranging from tablets and smart phones to notebooks and workstations.

Down from 25 in February it looks as if it has found a bottom at just under 15 and has now turned higher. The current Historical Volatility is 34.22 with an Implied Volatility Index Mean of 50.48, the IV/HV ratio is 1.48 and the put-call ratio at .29 is bullish. The option volume on Friday was 19,944 contracts compared to the 5-day average of 23,900 contracts.

Although it does not represent very much premium here once again is another put sale.



With a good volatility edge use a close below the last pivot at 13.62 as the SU (stop/unwind) or take the stock by assignment if it closes below the 14 strike price at the August expiration and then sell calls against the long stock position.


Takeover File

Next, here are three ideas in the takeover category to evaluate.

E*TRADE Financial Corporation (ETFC) 15.64. Online brokerage firm E*Trade experienced a two point advance on news the company will retain Morgan Stanley to conduct a review of strategic alternatives after rejecting a request by Citadel to hold a special shareholders meeting to consider putting the company up for sale. It appears Citadel partially accomplished its objective as the stock moved higher. However, this battle has been going on for some time as Citadel looks for a way out of this company.

After reaching 12.50, it gapped 2 points higher on the recent Morgan Stanley news. The current Historical Volatility is 54.53 with an Implied Volatility Index Mean of 46.78, up from 41.58 last week, the IV/HV ratio is .86, but the historical volatility most likely be returning to the 25-30 range in the near future. The IV change was ranked number five in our IV advance list on Friday, up 6.62 or 16.49%. The put-call ratio at .43 is bullish. The option volume on Friday was 36,162 contracts compared to the 5-day average of 21,610 contracts with more than 2,000 options trades in three call series.

Once again, we look at a put sale as a proxy long strategy.



This put strike is much closer to the current stock price so probability of being assigned the stock at the August expiration is considerably higher. However, we think this battle by Citadel to sell the company will continue for a long time thereby keeping the implied volatility elevated and providing the opportunity to sell calls against any long position resulting from receiving stock by assignment.

MedcoHealth Solutions Inc. (MHS) 65.96. The company provides pharmacy services for private and public employers, health plans, labor unions, government agencies.

Express Scripts Inc. (ESRX) 57.30. ESRX who also provides a range of pharmacy benefit management (PBM) services, has made an offer to acquire MHS for 28.80 in cash and .81 shares of ESRX for each MHS share. At the current price, it values MHS at 75.21. However there is a great deal of skepticism the combination with be approved by the Federal Trade Commission as reflected in the price of MHS.

From 55 the stock gapped higher on the takeover announcement. The current Historical Volatility is 44.85, but should settle in the 30 range in the near future. The Implied Volatility Index Mean is 23.32, down from 30.32 last week. The IV/HV ratio is .86, but we expect to see the historical volatility decline and the implied volatility increase as the drama unfolds over the next few months. The 3.0 put-call ratio is bearish most likely from put activity. The option volume on Friday was 22,365 contracts compared to the 5-day average of 18,810 contracts.

While we do not have an opinion on the chances of the deal being approved, we do think it will take a long time to be resolved and will therefore provide many option trading opportunities. Once again, we suggest starting with a put sale.



In the event the stock closes below the strike price on the August expiration, take the stock by assignment and then being selling out-of-the money calls against the long stock position.

Clorox Corporation (CLX) 74.36. CLX provides a wide range of consumer branded products from cleaning to water filtration and food. Carl Icahn has offered 80 to buy the company while encouraging them to seek alternative bids.

Twice the stock has recently gapped higher on the Icahn buyout offer activity. The current Historical Volatility is 29.72, with an Implied Volatility Index Mean of 20.66, down from 23.94 last week. The IV/HV ratio is .70 while the put-call ratio is bullish at .3. The option volume on Friday was 25,313 contracts compared to the 5-day average of 21,850 contracts.

With both the implied and historical volatility, low this suggestion takes a different approach for a change since we think it will be another long drawn out affair.



This bull call spread is reasonably priced, but without a volatility edge, as a direction trade relying upon Carl Icahn’s group to realize the value of this company. Use a close back below the 71 support area as the SU (stop/unwind).


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.



Unless there is a political compromise reached on the US borrowing limit before the markets open on Monday, we are expecting a large equity market decline on Monday. It could then be followed by an equally large gain when there is news of an agreement. For those experienced picking intraday lows it could be a trader's delight. 


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Like many others at this time of the year, we will be vacationing at the beach in Southern California for the next two weeks, so the next Digest issue will be August 15.


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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".