« April 2012 »

IVolatility Trading Digest™

Volume 12, Issue 16
Earnings Express

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Although expectations have already been reduced this is week the quarterly earnings reports really get moving as the number of companies scheduled to report greatly increases. The current momentum darlings are likely to attract particular scrutiny, as several appear overextended.

This week we have updates for three previous ideas from Digest Issue 14 followed by three new ideas including a rumored takeover. We begin with a brief strategy comment.



StrategyS&P 500 Index (SPX) 1370.26. From a technical perspective, a lot happened last week starting with a close below the active upward sloping trendline followed by a close below the 1378.04 support from February 29. By the end of the week, it appeared to be attempting to make a right shoulder rally in what could now become a complex Head & Shoulders Top pattern with two heads, although there could be some confusion about the left shoulder. However, it is clear that a close below the last pivot at 1358.98 made on April 11 would be a failure of the rally up from the pivot and would suggest a downside-measuring objective at 1300. While more caution and hedging is a good idea we would wait for a close below 1358.98 before adding many more put spreads to the strategy mix. A few disappointing earnings reports could do it.     

Although the technical picture deteriorated the VIX futures premium is sending a somewhat different signal as the premiums decline last week.

S&P 500 Index Implied Volatility (IVXM). Since last week, the Implied Volatility Index Mean increased from 14.74 to 17.77, while the CBOE Volatility Index® (VIX) increased from 16.70 to 19.55. The updated day-weighted average table follows.



The day weighting applies 10% to April and 90% to May resulting in the average premium of 1.98 or 10.10% shown above. Our alternative volume weighting between April and May results in a 7.14% premium.

For this short-term indicator the premium to the cash is a SPX sell signal suggesting professional expectations for the cash to increase toward the futures price. In the past premiums in excess of 20%, have usually preceded corrections, although not a precise timing tool it does appear to be a good way to measure professional hedging sentiment.




KB Home (KBH) 8.05. Here is the plan for this homebuilder first suggested in Digest Issue 12 with a follow-up in Digest Issue 13. The original April 11 put sale was for a credit of .58. Now that the stock has declined to support at 8 we suggest rolling the put out and down. Here is the adjustment.



The prices above are Friday's bid and ask as indicated. In the event it closes below 8 at the June expiration be prepared to take the stock by assignment and then sell calls.

Illumina, Inc. (ILMN) 47.17. In Digest Issue 14, we reported something new was about to happen since the implied volatility has risen to 45 and then provided a long call short put idea. We booked the suggestion at the Monday close for zero cost. However, on Thursday the stock closed below our SU stop at 50 so we closed the position Friday for a 3.75 loss according to the trade plan.  

Chipotle Mexican Grill, Inc. (CMG) 440.40. This fast-casual fresh Mexican restaurant chain is scheduled to report 1Q earnings on Thursday, April 19 after the close, with a consensus estimate of 1.92 per share and a whisper estimate of 1.95 per share. In Digest Issue 14, we suggested using a long April 420 straddle going into the report and booked it on Monday's close for a 24 debit.

As expected, the implied volatility has risen along with the stock price so the mark-to-market was 29.50 on Friday. Since the options expire this Friday, the position needs closing Thursday before they report. We are expecting a further increase in implied volatility going up to Thursday for this momentum stock.  


Quarterly Earnings Reports

Here is a new entry into the quarterly report category, although it was also our Best Calendar Spread selection Friday as well as second on the high IV/HV ratio list.

Gilead Sciences Inc. (GILD) 45.51. Gilead Sciences, Inc. is a biopharmaceutical company developing and marketing drugs to treat patients with infectious diseases, including viral infections, fungal infections and bacterial infections, with a specialized focus on cancer. Scheduled to report 1Q earnings on April 26 after the close, the consensus estimate is .93 per share. Here is the pertinent options data.

The current Historical Volatility is 19.09 and 20.11 using the Parkinson's range method, with an Implied Volatility Index Mean of 52.80 up from 46.71 last week. The IV/HV ratio is 2.77 and 2.63 using the range method to calculate the HV. Friday's put-call ratio was a bearish 1.50 while the volume was 44,244 contracts traded compared to the 5-day average volume of 22,670 contracts.

Since the bid/ask spread are wide we do not suggest the calendar spread and offer this alternative idea.



Since the April options expire Friday there is considerable time decay over the weekend, estimated at .25 making the Monday range .34 bid -.81 ask. We suggest using a .75 limit order and wait. In the event the market opens down, especially below the important pivot at 1358.98 mentioned above in the strategy section we suggest suspending this idea.  

Green Mountain Coffee Roasters Inc. (GMCR) 43.59. This implied volatility for this coffee company, scheduled to report 2Q earnings on May 3 after the close with a .64 consensus estimate, has been rising and we think it will continue rising as the earnings date approaches.

The current Historical Volatility is 65.19 and 43.85 using the Parkinson's range method, with an Implied Volatility Index Mean of 80.07 up from 72.03 last week. The IV/HV ratio is 1.23 and 1.83 using the range method to calculate the HV. Friday's put-call ratio was just bearish at .72 while the volume was 12,649 contracts traded compared to the 5-day average volume of 22,790 contracts.

Accordingly, here is another straddle trade plan to consider



After confirming the earnings report date, plan to close the position on May 2 as implied volatility should continue rising.  


Takeover File

The result of a rumor, here is a new entry for the takeover file.

Safeway Inc. (SWY) 21.19. The company operates supermarkets including Vons, Dominick's, and Randalls throughout the Western, Southwestern, Rocky Mountain, Midwestern and Mid-Atlantic regions of the United States and western Canada.

The current Historical Volatility is 29.32 and 25.48 using the Parkinson's range method, with an Implied Volatility Index Mean of 41.68 up from 27.94 last week. The IV/HV ratio is 1.42 and 1.64 using the range method to calculate the HV. Friday's put-call ratio was extremely bullish at .20 while the volume was 27,887 contracts traded compared to the 5-day average volume of 13, 770 contracts.

While keeping an eye on the important pivot at 1358.98 mentioned above in the strategy section consider this long call spread short put combination.



Considering the time decay over the weekend the April 22 put should be around 1.05 Monday reducing the expected credit to .60. Use a close back below 20 as the SU (stop/unwind).


The suggestions above, except for Gilead and KB Home 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.


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From a technical perspective, the equity markets are showing signs of developing top patterns with the potential for an additional 5% correction although our VIX futures premium indicator has declined and seems to suggest less concern. 


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In next week's issue, we will review all of our market indicators in detail and update the technical status of the equity markets.


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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".