« December 2011 »

IVolatility Trading Digest™

Volume 11, Issue 49
Holiday Pressure Relief

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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With the political activity relating to the sovereign debt crisis most likely to diminish this week, we speculate there will be fewer downgrade announcements coming from the rating agencies along with an absence of central bank comments, which could mean there could be some pressure relief going into yearend. If so, equities could still make a modest attempt at the anticipated yearend rally despite the overall negative macro environment. However, to be on the safe side we offer a hedge strategy idea, followed by two previous suggestion updates, a new quarterly earnings report idea along with a review of the newly announced takeover deals and another takeover suggestion.



StrategyIn spite of the perilous European sovereign debt issue there still is a good chance by Wednesday market volume will again decline to typically lower holiday levels along with a continuing decline in volatility as measured by the CBOE Volatility Index® (VIX) 24.29. However, the VIX premium over the cash is now up to 17.87% using the day-weighted method and 14.17% calculated by volume weighting. The higher VIX premium over cash along with last week's significant deterioration in market breadth implies some hedging is now prudent.  

SPDR S&P 500 (SPY) 121.59.

As we are anticipating implied volatility will continue to decline, here is a precautionary put spread strategy.

The current Historical Volatility is 25.30 and 16.89 using the Parkinson's range method, with an Implied Volatility Index Mean of 22.98, up from 22.96 the prior week. The IV/HV ratio is .91 and 1.36 using the range method to calculate the HV. The put-call ratio is understandably bearish at 1.77, since it is widely used for hedging.

Consider this put spread as a hedge.

At 27% between the strike prices and with some short put edge this is an attractive hedge. Use a close back above 127 as the SU (stop/unwind).



Here are two updates from Dave's corner.

Oracle (ORCL) 29.21

Here is an update from Digest Issue 45.

The plan was to purchase a 32 call and simultaneously sell a 34 call and a 29 put. On November 25 when it closed at 28.74, the call spread portion of the plan was closed.

We booked the original trade on Monday November 21 for a .58 credit. As we unwound the call spread, we added an estimated additional credit of .12, so the record is now a credit of .70.

ORCL is scheduled to announce 2Q earnings on Tuesday December 20, after the close. The consensus estimate for earnings is .57 per share with a whisper of .59 per share.  

The current Historical Volatility is 39.25 and 28.00 using the Parkinson's range method, with an Implied Volatility Index Mean of 34.51, up from 34.26 the prior week. The IV/HV ratio is .88 and 1.23 using the range method to calculate the HV. The put-call ratio is bearish at .90, which could be attributed to hedging the upcoming earnings report.

Since analysts continue to say positive things about this stock, an earnings surprise outside of the analysts estimated range could create a breakout.

An upside breakout could be captured by a 31/33 call spread while using a 26 put sale to finance the call spread. Further, the strike price of the put is near the lows set in late August.



The risk is ORCL moves below support near 26, so be prepared to take the stock by assignment in the event it closes below 26 at the January expiration.

Research In Motion (RIMM) 13.44

Here is an update for Digest Issue 48.

The plan was to purchase a 17.5 call and simultaneously sell a 19 call and a 14 put. On December 17, our short put would have been assigned, creating a long stock position with a basis of 13.93, .49 higher than the current closing price. The negative sentiment is extreme, and there is little support technically. With the Relative Strength Index (RSI) moving below 25, the share price could see a quick retracement, before additional selling comes back. We suggest looking for an opportunity to exit this position by selling the stock.

Quarterly Earnings Report

Here is another in our continuing series of earnings report ideas. This one was highlighted since it ranked number three in our IV/HV scan and number one at the top of its 52-week range implied volatility range. 

Walgreen Co. (WAG) 34.13 operates a chain of drugstores in the US selling prescription and non-prescription drugs along with general merchandise.

The first quarter earnings report is scheduled for release before the opening on Wednesday December 21. While both the analyst consensus estimate and the whisper estimate are .67 per share, much scrutiny will be given to the reported sales.  

The current Historical Volatility is 32.18 and 27.39 using the Parkinson's range method, with an Implied Volatility Index Mean of 44.38, up from 41.73 the prior week. The IV/HV ratio is 1.38 and 1.62 using the range method to calculate the HV. The put-call ratio is extremely bullish at .23 with 4.33 times more calls traded than puts on Friday with total options volume at 29,620 contracts compared to the 5-day average of 40,110 contracts.

As an illustration of the positive expectations for WAG, below we have the volatility chart for the last year showing the current high level of implied volatility. In addition, it shows the attractive IV/HV ratio, which is the difference between the implied volatility at 44.38 in orange, and the historical volatility at 32.18 in blue, using the standard at annual rate of change method for a ratio of 1.38. The advantage is even more favorable when using the range method at 27.39 increasing the ratio to 1.62. Since the chances are high that the implied volatility will decline substantially after the earnings report, the plan is to be short more options than long. See the trade plan below the volatility chart.



Consider this call spread, short put combination.



For those who may want to have a long WAG position, an alternative is to sell the Jan 31 put, with an indicated Friday price of .75, reducing the debit to .01, but increasing the risk of being assigned the stock at the January expiration. 


Takeover File

We were encouraged by the three new takeover deals announced last week, but upon closer review, they did not seem to be very attractive from an options perspective. However, the lack of any increase in stock or options volume prior to the announcements was noticeable. For now, it appears insider trading has been greatly reduced.

Vulcan Materials Company (VMC) 38.78. On Monday, Martin Marietta (MLM) 74.44 proposed a hostile takeover offering one-half of one MLM share for each VMC share. Monday the options volume was 22,343 contracts, but by Friday, it had declined to 3,256 contracts while the implied volatility declined from 51 to 44. It appears this will be long drawn out affair and there is not much speculative enthusiasm since there does not appear to be any third party bidders interested in offering a better deal. We will review this one again, but for now, we do not see any interesting trade ideas.

Novellus Systems, Inc. (NVLS) 40.18. Wednesday, Lam Research (LRCX) 35.92 announced that it had reached an agreement to acquire NVLS in an all-stock deal giving 1.125 shares of its stock for each NVLS share, indicating a 28% premium. This deal could be more interesting since there are several competitors they may now be inspired to make offers for NVLS. In addition, several law firms announced they were initiating investigations into potential claims against the board of directors of NVLS. While this one should generate more options interest it was not yet evident as the options volume declined to 3,194 contracts on Friday compared to Thursday's 51,960 contracts and the implied volatility was almost unchanged for the week. Perhaps the activity will pick up in 2012.  

RSC Holdings, Inc. (RRR) 17.95. Friday United Rentals Inc. (URI) 27.89 said it has agreed to buy rival equipment rental company RSC Holdings for about 1.9 billion in cash and stock. The 18-per-share offered price is a 58 percent premium to RSC's closing price on Thursday. Completion of the approved deal is expected in the first six months of 2012. When the deal closes, each outstanding share of RSC common stock will be converted into the right to receive 10.80 in cash and 0.2783 of a share of United Rentals common stock. The deal is subject to closing conditions, including regulatory approval and clearance of any antitrust hurdles. Unfortunately, from an options perspective this one is not attractive since the options volume is much too thin, with only 1,966 contracts traded. However, if a third party enters the bidding volume and liquidity it could increase.

Yahoo! Inc. (YHOO) 14.96. YHOO is a digital media company in the process of reorganizing or perhaps being sold. Although having declined from 16.50, high options volume continues based upon speculation that Jack Ma and others are working on a plan to acquire the company. Rumors have the price in the 18-20 range.

The current Historical Volatility is 26.69 and 24.03 using the Parkinson's range method, with an Implied Volatility Index Mean of 48.54, down from 50.19 the prior week. The IV/HV ratio is 1.82 and 2.02 using the range method to calculate the HV. The put-call ratio at .34 remains extremely bullish, as it has been for several weeks. On Friday's there were nine strike prices with volume in excess of 2K contracts. The January 17.5-call option volume was 33,668, the 16 call was 60,179 and the 14 call was 45,673, although a good portion could be spreads being rolled over from December to January. Friday's option volume was 326,207 contracts compared to the 5-day average of 171,950 contracts.

Our last suggestion used January options. Here is another, this time with April options for the call spread.



Use a close back below 14.50 the SU (stop/unwind) or be prepared to take the stock by assignment in the event it closes below 14 on the January expiration. If so, then the plan is to sell calls against the stock position. Otherwise, the plan is to keep selling the puts to reduce the cost of the call spread.

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.

As the holiday season approaches, we are again offering special discounted rates on our data services. Here is more information about how to acquire your customized data service to help find those special volatility events and other advantageous trading ideas.



IVolatility's Holidays Special Offer



As the European political leaders along with the ratings agencies and central bankers reduce the number of news releases and prepare for the holidays, there is a chance that without the endless flow of negative news from Europe equities could still make a modest yearend rally.


IVolatility.com Bookstore  In addition to the vast number of articles and other information on our web site, take a browse through our bookstore for more reference information and material.

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While this is the final Digest issue for 2011, we will return with a special mid-week Market Review issue on January 4, 2012.


Finding Previous Issues and Our 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.

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Hi there, Please could you advise on how i can learn how to use ivolitility with my fx trading.I don't trade proffesionally but have been trading the fx cable market for some years now but would wish to learn more, please advise. Kind regards Karl.

Posted by Karl Fraser on December 20, 2011 at 02:19 AM EST

Karl, Thanks for the question; sorry for the delay in answering, I was away for Christmas. As you know most of the foreign exchange is done interbank and we do not have access to volume and open interest data like the futures markets. While there is some trading in British Pound futures the volume is not very high so some caution in required when looking at the data. In addition to BP/USD, there are 23 other cross rates quotes in the futures markets listed in our Advanced Futures Options service. For example, enter BP with the exchange set for CME and it will return the price chart along the volatility chart. We suggest setting the HV (historical volatility) to 21 days and then compare the IVX Mean 30 (Options Implied Volatility Index 30-day Mean) to the historical volatility. At the Futures Options tab, you will find data on the traded options. Generally, the IVX is about 1-2% higher than the historical volatility. An alternative is to look at the Currency Shares ETF (FXB) in the Advanced Historical Data and Advanced Options sections. This would not require a separate subscription to the futures service and the IV/HV relationships are somewhat similar, but the trading volume is very small. While the spread between the IV and HV is usually 1-2% in late September it rose to about 5% and has been declining since. Both the futures and options markets provide some additional insight into the currency markets and should be a part of any serious currency trader’s toolbox, while remembering the volume are small and represent only a small fraction of the actual currency trading. Jack

Posted by Jacktrader ( on December 30, 2011 at 01:34 PM EST

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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".