« August 2011 »

IVolatility Trading Digest™

Volume 11, Issue 33
Buffet's Boost

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Opportunities GaloreAlthough expectations for more stimulus measures were about right going into Ben Bernanke's Friday speech, the markets received a surprising boost when Bank of America announced it would sell Berkshire Hathaway $5bn of preferred stock in a vote of confidence for the bank and the entire banking sector, which had been in a serious decline. Buffet's helping hand was offered just in time to help stabilize the equity markets sending the short sellers scrambling for cover.                                                

Since option implied volatility appears to be in retreat again, we offer four ideas that should benefit from the continuing decline. First, a brief strategy comment.




Although the cash CBOE Volatility Index® (VIX®) 35.09 remained elevated on Friday our day-weighted VIX Futures discount to cash was -7.16%, compared to the prior week at -18.93%. For this short-term indicator the discount to the cash is a SPX buy signal indicating professional expectations for the cash to decrease back toward the futures price.

Premium over cash 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, like the current one, have been good leading indicators for short-term market advances in the past.

The current technical condition of the S&P 500 Index (SPX) 1176.80 is creating a greater challenge since it appears to be in the process of forming a symmetrical triangle consolidation pattern. It has a high likelihood of it being a continuation pattern and since it was formed on the downside with the August 8 low of 1101.54 being reversal point one, it suggests the continuation will be lower. Any close in the next few days below Fridays low will most likely activate the pattern.

While the VIX futures discount to cash suggests the VIX will decline as the SPX rises, we suggest giving due respect to the developing technical mentioned above pattern. Therefore, our suggestions are conditional assuming SPX does not close below Fridays low. If the market is lower on Monday, we suggest considering a hedge strategy like to one in Digest Issue 28 using Direxion Small Cap Bear 3X Shares (TZA) 47.59.


Helping Hand

Assuming Berkshire's helping hand is enough to stabilize the important banking sector making up approimately 30% of the S&P 500 Index here is a suggestion to go with the flow.

Bank of America Corporation (BAC) 7.76

The current Historical Volatility is 113.37 with an Implied Volatility Index Mean of 81.11, down from 100.67 last week. We are expecting they will both be declining back into the 50 range. The IV/HV ratio is.72 while the put-call ratio at .775, is bearish, but understandable considering the amount of hedging being done. Friday’s option volume was 857,594 contracts compared to the 5-day average of 1,243,380 contracts. There were 16 call strikes with volume in excess of 3,000 contracts each. Consider this bull call spread with a short put for some implied volatility edge.



Use a close back below the last pivot at 6 as the SU (stop/unwind).


Copper Bottom

Here is one assuming the bottom of the recent range for copper holds and prices now start working their way higher once again.

Freeport-McMoRan Copper & Gold Inc. (FCX) 44.53.

Although there is news of a potential strike at their mine in Indonesia it has not stopped the options implied volatility from declining along with the VIX and many others.

The current Historical Volatility is 56.52 with an Implied Volatility Index Mean of 47.03, down from 58.92 last week. We are expecting they will both be declining back into the 40 range, the IV/HV ratio is.83 and the put-call ratio at .50 is bullish. Friday's option volume was 98,552 contracts compared to the 5-day average of 79,270 contracts. There were 5 call strikes with volume in excess of 2,000 contracts each. Here is another one of our combination suggestions.



There is good volatility edge in the put to offset any lack of edge in the call spread. Watch for a close below the last pivot at 41.46 as the SU (stop/unwind).

Offshore Oil Production

Although August typically is the seasonal high for crude oil prices, we think there is a good chance the current lows around $80 per barrel for West Texas Intermediate crude will hold since it peaked at $115 on May 2 and has been declining since. Currently the correlation with equities and risk assets seems to be more important than the normal seasonal demand patterns.

Here is an idea for stable or higher crude oil prices.

ATP Oil & Gas Corp. (ATPG) 13.87. ATPG is an oil and natural producer in the Gulf of Mexico, the United Kingdom, and the Dutch sectors of the North Sea. On Thursday they announced the their third well on the Telemark Hub in the Mississippi Canyon of the Gulf of Mexico began producing 7,000 barrels of oil per day, bringing the total platform production up to 31,000 barrels per day. A fourth well is expected to begin producing later in the year.

The current Historical Volatility is 159.76 with an Implied Volatility Index Mean of 126.22, up from 122.41 last week. We are expecting they will both be declining back into the 60 range, the IV/HV ratio is.90 and the put-call ratio at .90 is bearish, but probably due to hedging. Friday’s option volume was 19,302 contracts compared to the 5-day average of 11,730 contracts. It was ranked number eight in our implied volatility change category with an increase of 6.98%, when most were declining suggesting perhaps more than just the increased production announcement could be involved.



The near term September put has good volatility edge and there appears to be good support at 10. Use a close back below the last pivot at 9.26 as the SU (stop/unwind).


Retail Restructure Story

Here is a retailer that announced it was closing 475 underperforming stores sending the short sellers scrambling to cover their positions.  

Collective Brands, Inc. (PSS) 12.70. PSS the holding company for Payless ShoeSource and Stride Rite with 4,458 stores, announced Thursday the closing of 475 underperforming or non-strategic stores. The stock, which had been in a downtrend since March, quickly advanced closing up 1.91 on what appears to have been short covering since there was a reported short interest of 27.7% as of August 15, according to Bloomberg. Apparently, the shorts are no longer willing to take further risk since management is taking action to improve profitability.

The current Historical Volatility is 83.38 with an Implied Volatility Index Mean of 65.06, down from 81.79 last week. The normal volatility range appears to be in the mid forties range with spikes to 60 near earnings report dates. The IV/HV ratio is .78 and the put-call ratio is bullish at .30. Friday's option volume was 9,108 contracts compared to the 5-day average of 11,710 contracts. It was ranked number four in our implied volatility change category with an increase of 11.00% when most were declining.

If the recent rally was simply short covering chances it will not have very much more momentum, but the options implied volatility is likely to decline.

Here is a put sale idea for this situation.



There appears to be good support at 10 where it was trading before the last earnings report and the store-closing announcement. In the event is closes below 12 at the October expiration be prepared to take the stock by assignment and then wait for the run up to the next earning announcement to sell a call as the implied volatility rises. 


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.


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While our indicators look positive for equities and with the recent support for the banking sector the equity market should continue working higher, but first there is a worrying continuation pattern that needs to be resolved and it should be known in the next few days if not Monday.


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In next week's issue, we will review all of our indictors once again and update the status of the market direction.


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.


Next week’s issue As usual, we encourage you to let us know what you think about how we are doing and what you would like to see in future issues. Send us your questions or comments, or if you would like us to look at a specific stock, ETF or futures contract, let us know. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website. If you would like to receive the Digest by e-mail let us know at Support@IVolatility.com




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Very interesting, so where and how do I avail my self of that indicator "the day rated Vix futuresdiscount to cash" so I can compre that to the cboe vix like you did in this issue?

Posted by Eugene Ellis on August 30, 2011 at 12:17 AM EDT
Website: http://mrdui.com

I'm afraid to ask this one: in your suggeated trades what does the 0/c stand for?

Posted by Eugene Ellis on August 30, 2011 at 12:35 AM EDT
Website: http://mrdui.com


Thanks for the VIX futures question. In the Market Review section of every other Digest, we provide the details for the computation. Go to Digest Issue 32 by using the small calendar at the top right side of the Digest page.

On a day-to-day basis, a simple way to do it would be to compare the cash VIX with the nearest two futures contracts and compute the amount of premium or discount. An average of the two, while not exact as a day-weighted average, will provide an estimate. Another alternative would be to use the contract with the most volume and/or open interest. Currently it would be September, the front month. However, as the expiration approaches the premium or discount, as it is currently, will diminish, therefore we use a day weight average of the two front months to determine the premium or discount.


Posted by Jacktrader ( on August 30, 2011 at 12:57 PM EDT


Thanks again for the question about o/c. In our tables of suggested trading ideas, we use O/C as an abbreviation for Open or Close, as in an opening or closing trade. Currently the Digest has been making mostly suggestions for opening trades, so they will usually be ā€œO.ā€ There have been times in the past, and we may do it again, when we have suggested closing a previous suggestion and then ā€œCā€ would appear in the column.


Posted by Jacktrader ( on August 30, 2011 at 01:07 PM EDT

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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".