« November 2011 »

IVolatility Trading Digest™

Volume 11, Issue 43
Focus on Quarterly Earnings

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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For the last several weeks, as we have been trying to keep pace with the debt negotiations in Europe while our trade suggestions have been neurotically battered back and forth from "risk-on" one day to "risk-off" the next, as volatility remains high creating challenges and some opportunities. Since it appears, any comprehensive solution to the Greece debt crisis is still a long way away, this week we will turn our attention to some ideas for the upcoming earnings reports. After a brief strategy comment, we have one update, a new seasonal trend proposal and then five earnings report ideas followed by a new biotech idea.



StrategyS&P 500 Index (SPX) 1253.23. The positive news from Europe that had created the potential flag pattern in our last Digest was quickly destroyed as it became obvious any optimism about a debt settlement plan for Greece in the near future is misplaced. The G-20 summit meeting in Cannes, last Thursday and Friday was nothing more than a photo op. As a result, we will again designate as the active pattern the measuring objective from the previous range breakout, which is the vertical height of the range it broke away from or about 156 points, up to 1387.

However, the one important thing to remember about November is that October, the month with the notorious record of being the weakest of the year, is now over. Seasonally both November and December are favorable for equities and one can make the case for a small developing upward sloping trendline from the October 4 low at 1074.77. Since we have an upside objective from the range at 1387 the only obstacle is resistance in the 1350 area. Of course, this ignores any further dollar strength from euro weakness and the seemingly intractable European debt problem that causes additional trouble for equities.  

As for our VIX futures premium indicator, the day weighting applied 35% to the November contract and 65% to December resulting in the average premium of .23 or .77%. Last week in Digest Issue 42, the premium was 5.87% and a reversal followed. However, recently reversals have been associated with higher readings, both positive and negative.


Here is an update that belongs in the "Coulda, Shoulda, Woulda" category to a suggestion in the Quarterly Earnings section of Digest Issue 41.

ARM Holdings plc (ARMH) 31.21. UK based ARMH designs and licenses high performance, low-cost, power-efficient RISC microprocessors and related technology and software.

While we often suggest using a long call spread in combination with a put sale, in Digest Issue 41 our suggestion was limited to the sale of a November 24 put. Now since ARMH broke out to the upside on Friday and since this is the season for tech stocks, we suggest adding a long call spread, although admittedly late.

The current Historical Volatility is 49.51 and 35.84 using the Parkinson's range method, with an Implied Volatility Index Mean of 48.97, up from 44.62 last week. The IV/HV ratio is .99 and 1.37 using the range method, with the put-call ratio very bullish at .25. Friday's option volume was 25,715 contracts compared to the 5-day average of 8,830 contracts.



Although this spread does not have a volatility edge, it offers further participation in the seasonal tech trade and when combined with the put sale in Digest 41 makes a good combination. 

Seasonal Trend

SPDR Gold Shares (GLD) 170.85.

With the seasonal advantage underway for gold, there is now a definable uptrend from the October 20 low of 156.05, touching the November 1 low at 165.61. Ideally, we would like to see another point on the trendline but with the seasonal help we are satisfied to enter the trade now, using a close back below the November 1 low at 165.01 as the SU (stop/unwind).

The current Historical Volatility is 21.48, and 17.81 using the range method, with an Implied Volatility Index Mean of 25.29, up from 23.14 last week. The IV/HV ratio is 1.18 and 1.42 using the range method, while the put-call ratio is bearish at .70, however since this ETF is used for hedging other gold positions higher put volumes should be expected. Friday's options volume was 217,275 contracts compared to the 5-day average of 231,920 contracts.

Consider this January call spread.



While there is no volatility edge, there is also no volatility disadvantage, which often occurs with long call spreads, while it does provide a relatively low cost seasonal opportunity in the gold sector.


Quarterly Earnings

McDermott International Inc. (MDR) 11.99. MDR is an engineering, procurement and construction company focused on offshore oil and gas projects.

We suggested a long call short put combination in Digest Issue 39. The October put expired for a .15 credit based upon our next Monday close record date, so presently the record is a net .60 debit for the still long November 15/18 call spread.

On October 26 the company reduced guidance for the third quarter ending September to .03 -.05 per share and the stock immediately closed off 3.66. They are scheduled to report third quarter on Tuesday after the close.  

There is a good chance all of the bad news is now in the stock so we are going to suggest using another put sale as a recovery trade.

The current Historical Volatility is 114.187 and 78.63 using the range method. The Implied Volatility Index Mean is 71.68, down from 76.55 last week, for an IV/HV ratio of .63 and .91 using the range method. The put-call ratio is just bearish at .80. On Friday the options volume was 9,162 contracts compared to the 5-day average of 6,180 contracts. Consider this recovery idea.



In the event it closes below 12 at the November expiration be prepared to take the stock by assignment and then sell calls against the long stock.

Green Mountain Coffee Roasters Inc. (GMCR) 70.82. This company in the specialty coffee and coffee maker business is scheduled to report fourth quarter earnings on Wednesday after the close. The consensus estimate is .48 per share.

We suggested a bearish December put spread in Digest Issue 41, long the December 60 put and short the December 50 put. We booked the suggestion, which is still open for a debit of 2.02. The stock bounced off 60 and gained 9 points in the last two trading days. We presume on earnings expectations.  

While we suggest keeping the put spread in place we also suggest lowering the SU (stop/unwind) to a post earnings report close above the downward sloping trendline at 78.  

NVIDIA Corporation (NVDA) 14.67. 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.

The put sale suggestion we made in Digest Issue 30, either resulted in a long stock position or was bought back at a loss on August 4 as it closed below 13.62.

They are scheduled to report third quarter earnings on Thursday after the close with a consensus estimate of .26 per share and a whisper number of .28 per share.

The current Historical Volatility is 62.27 and 51.49 using the range method, with an Implied Volatility Index Mean of 61.71, up from 55.78 last week. The IV/HV ratio is .99 and 1.20 using the range HV and the put-call ratio is almost bearish at .60. The option volume on Friday was 22,288 contracts compared to the 5-day average of 24,990 contracts.

Since the seasonal tendency is now more favorable for the tech sector here is another put sale idea.



Use a close below the last pivot at 13.53 as the SU (stop/unwind) or take the stock by assignment if it closes below the 14 strike price at the November expiration and then sell calls against the long stock position.

Molycorp, Inc. (MCP) 40.18. MCP focuses on the development, production and sale of rare earth oxides from stockpiled raw material. In addition, they have been acquiring companies related to rare earth materials.

MCP is scheduled to report third quarter earnings on Thursday after the close with a consensus estimate of .69 per share. In August, they reported .52 per share.  

The current Historical Volatility is 78.84 and 77.60 using the range method, with an Implied Volatility Index Mean of 79.29, up from 74.88 last week. The IV/HV ratio is.99 and 1.02 with the range HV, the put-call ratio at .50 is almost bullish. Since the stock is in the middle of the 30-50 range, consider this strangle idea for the earnings report.



In the event it closes below 30 at the November 30 expiration be prepared to take the stock by assignment and then sell calls. In the event the stock increases and closes above 50, stock should be brought in to deliver against the short position when the stock is called away.


Dave's Corner

Rich Volatility Creates Selling Opportunity

General Motors (GM) 23.61

General Motors is scheduled to report earnings Wednesday November 9, 2011 before the opening with a consensus estimate of .99 per share. Since option volatility is high, it creates an opportunity to sell options.
For GM, the past quarter EPS was up 81%, and the company has a PE ratio of 6. Sales are up 19% quarter over quarter and the stock is in a 52-week range between 19.73 and 38.98.

Technically, GM has held support near the 50-day moving average at 22.75, and negative sentiment has been built into the stock, after GM announced disappointing car sales for October. The upside is capped by the 100-day moving average near 25.50.

The average at-the-money implied volatility at 50.26 is near the 52 week high while the HV is 56.90 and 44.71 using the range method, for an IV/HV ratio of .87 and 1.10 using the range method. Since the normal IV is in the mid 35 range it makes selling volatility attractive.

A strangle incorporating the technical support and resistance levels is an attractive strategy given the current high volatility level.



With a good bit of volatility edge, set the stop loss on a close above $27 or a close below $20. Take profit at expiration.


Biotech Idea

Our friends at TradeToBeFree.com sent us this idea.

Celgene (CELG) 63.73.  

Below is one of the best trading setups featured over the past week in our newsletter. Celgene recently reported a solid quarter where they beat by 7 cents per share on the bottom-line. Consensus estimates for next year have gone up over 5% over the past 7 days. Sales growth has averaged 30% per year over the past 3 years and earnings growth has averaged over 41% over the past five years. The PEG ratio is a very reasonable .68. Stocks with this kind of consistent growth and rising estimates (combined with other key metrics) have historically beat the market by a wide margin.

The price of Celgene is pulling back to an unconfirmed uptrend support, which is typical after an earnings release like this. However, once the price breaks the short-term downtrend resistance shown in the chart below, many of our subscribers will jump in and buy call options with a good chance of success. Another good entry point is once the overbought/oversold oscillators start moving out of oversold levels. It may take a few weeks so the December calls would be a good place to look, as we get closer to expiration this month. The chart with the downtrend resistance drawn is displayed below.



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.



Although still vulnerable to further setbacks from the European debt negotiations that could cause more euro weakness, the equity market is now showing an upside bias that could continue until the end of the year.


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In next week's issue, we return with our complete market review along with more timely suggestions.


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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".