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Pressure on the Eurozone was unexpectedly increased Friday when Jürgen Stark announced his resignation from the ECB executive board exposing serious divisions between the members over recent bond purchases of Italian and Spanish debt. While we have been expecting volatility to remain high until the September 29 German Bundestag vote on the European Financial Stability Facility, this action will surely increase doubts about the outcome.   After a brief strategy comment, we have some trading ideas for this elevated volatility environment.
Strategy While the euro had been declining for the last week, on Friday it broke down below support in the 1.40 area. Considering the current momentum, it looks like it could continue lower to the next support around 1.30. The declining euro will push the US dollar index higher and unless the recent correlations begin to change equities and commodities will be pressured lower as well. Below we have two trade ideas that should work for this situation. With the added uncertainty from Europe, we suggest hedging existing long positions while limiting news ideas to special opportunities such as the four other ideas below.
Whacking the Euro As for the euro, here is an addition to the suggestion we made in Digest Issue 25 using EUO. On a mark-to-market basis, the November 18/20 call spread has increased in value from .45 to .65. Here is the new breakout trade suggestion for the euro. ProShares UltraShort Euro (EUO) 18.60. The ETF seeks to provide daily move corresponding to twice (200%) the inverse (opposite) of the daily change in the US dollar price of the euro. The fund invests in swap agreement, futures contracts, forward contracts, option contracts. The current Historical Volatility is 25.12 while the Parkinson's range method, arguably more applicable for EUO is 14.21. The Implied Volatility Index Mean is 38.61, up from 30.78 last week, for an IV/HV ratio of 1.54, however comparing the Implied Volatility to the range Historical Volatility the ratio is 2.7. The put-call ratio is .05 or about 20 times more call volume than puts with a similar ratio between call and put open interest. Friday’s option volume was 33,487 contracts compared to the 5-day average of 21,380 and much higher than in June when we first suggested the EUO call spread. Here is another call spread idea.
With a good volatility edge, the debit is a favorable 21.50% of the distance between the strike prices providing an attractive 4:1 risk to reward ratio. Use a close back below the last pivot just under 16.50 as the SU (stop/unwind). With similar gamma, or rate of change of delta, as the previously suggested long November 18/20 call spread there is less time value since we are expecting EUO to advance during the next month.     Hedging Equities If the euro continues to decline and the current correlations remain unchanged then we should also hedge our equity exposure, however we want to make this suggestion conditional upon the S&P 500 Index (SPX) 1154.23, closing below Friday's low at 1148.37. The reason for making this suggestion conditional is based upon our expectation that the European leaders will most likely be working this weekend and there is no telling what they may say by Monday to support the euro. Direxion Small Cap Bear 3X Shares (TZA) 48.66. This ETF seeks daily results, before fees and expenses, of 300% of the inverse (or opposite) of the price performance of the Russell 2000 Index. The current Historical Volatility is 167.53, while the Parkinson’s range method 121.53. The Implied Volatility Index Mean is 134.64, up from 118.98, for an IV/HV ratio of .80, however comparing the Implied Volatility to the range Historical Volatility the ratio is 1.11. The put-call ratio is .22 or about 4.5 times more call volume than puts while the call open interest is more than 2 times the put open interest. Friday's option volume was 39,316 contracts compared to the 5-day average of 29,980. Here is a long call spread as a hedge, but without much volatility edge.
The increasing price of the ETF corresponds with the expected decrease in the price of the Russell 2000 Index. In the event the market turns higher once again use a close back below 40, as the SU (stop/unwind).   Special Opportunities Seasonal Here is one we have in the seasonal category since this is about the time of the year when the technology group starts turning higher and checking the charts of several companies in the group confirms they now have begun to trend higher even in the current uncertain market environment. NVIDIA Corporation (NVDA) 13.88. 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. After raising guidance, the stock gapped higher on Wednesday closing up 1.07. The case can now be made that the downward sloping trendline in place from May has been broken by the gap up. The current Historical Volatility is 78.43 with an Implied Volatility Index Mean of 68.44. The IV/HV ratio is .87. If the uptrend continues both volatility measures should soon be declining back into the 50 range. The put-call ratio at .52 means there were 1.9 times more calls traded on Friday than puts with the open interest favors calls by about 1.5 times more than puts. The Friday option volume was 27,601, contracts compared to the 5-day average of 41,120 contracts. Here is a put sale suggestion considering implied volatility will likely decline in the near future.
Use a close below the last pivot at 12.38 as the SU (stop/unwind) or take the stock by assignment if it closes below the 12 strike price at the October expiration and then sell calls against the long stock position.   Offshore Drilling Admittedly, this idea seems odd at this time, but this one is a somewhat unusual dividend opportunity in the oil service group.   SeaDrill Limited (SDRL) 30.85. Hamilton, Bermuda based Seadrill Limited is an offshore drilling contractor, providing offshore drilling services to the oil and gas industries worldwide. As of March 31, 2011, the company owned and operated 54 offshore drilling units, consisting of drillships, jack-up rigs, semisubmersible rigs, and tender rigs for operations in shallow and deepwater areas, as well as in harsh environments. With Norwegian management, they are active in the North Sea. The annualized .75 quarterly dividend rate yields a 9.7% return at the current stock price and there are no indications the current dividend rate will be reduced. The current Historical Volatility is 74.40, while the Parkinson's range Historical Volatility is 42.33. The Implied Volatility Index Mean is 48.10 for an IV/HV ratio of .65, but 1.14 using the range method. We forecast the volatility measures will return to the 30 area in the near future. The put-call ratio at 1.80, means there were 1.8 times more puts traded on Friday than calls, while the call open interest exceeds the put open interest by 1.7 times. The Friday option volume was 2,184 contracts compared to the 5-day average of 14,110 contracts. Here is a put sale suggestion considering implied volatility will likely decline in the near future.
The strategy of using a put close to the current price is to increase the chances of being assigned the stock on a close below 29.80 at the October expiration. If assigned the basis in the stock would be 28.38 and represent a 10.6% yield assuming the dividend rate is maintained. This position offers exposure to the offshore drilling sector with a good current yield that helps to support the stock price when the markets sell off.   Top of the Range Here is an idea from the top of the 52-week implied volatility range. InterDigital, Inc. (IDCC) 64.28. The company designs and developments digital wireless technology and has created an extensive patent portfolio. The stock price increased in July on speculation they were considering the sale of patents. We offered a put sale suggestion in Digest Issue 30 for the sale of the August 55 put that has since expired. Here is one more.   The current Historical Volatility is 92.26, while the Parkinson's range Historical Volatility is 75.62. The Implied Volatility Index Mean is 129.81, up from 126.50 last week, for an IV/HV ratio of 1.41, but 1.72 using the range method. We forecast the volatility measures will return to the 60 area in the near future. The put-call ratio at .20, means there were 5 times more calls traded on Friday than puts, while the call open interest exceeds the put open interest by 2 times. The Friday option volume was 28,634 contracts compared to the 5-day average of 16,660. The high-implied volatility is an indication of the potential for a large move so we have selected a put far out- of- the money.
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. Using the Implied Volatility Index Mean of 129.81 the 45 put is within the range of a one standard deviation move with a 43% probability. Using the Historical Volatility of 92.36 it is at one standard deviation with a 26% probability and with the range method at 75.62 it is beyond one standard deviation with a 17% probability. Although the Implied Volatility is currently rising again, we forecast it will decline back to about 60.   Takeover File Yahoo! Inc. (YHOO) 14.48 YHOO is a digital media company. We suggested a call spread with a short put combination for YHOO in Digest Issue 31. Initially priced at a .15 credit, the mark-to-market value on Friday was .62 from a slight price increase and higher implied volatility. On Friday, YHOO was ranked number one in our Trend Selection with a bullish rank of 50% and was in the number 3 ranked position in the Top Range category. With the recent management changes and with more likely to come we once again have YHOO in the Takeover File. The current Historical Volatility is 65, while the Parkinson's range Historical Volatility is 47.39. The Implied Volatility Index Mean is 64.36, up from 50.36 last week, for an IV/HV ratio of .99, but 1.36 using the range method. The put-call ratio at .51, means there were 1.9 times more calls traded on Friday than puts, while the call open interest exceeds the put open interest by 2 times. The Friday option volume was 108,304 contracts compared to the 5-day average of 191,410. Since it is likely to take some time before the management issues or any potential takeover is resolved, we suggest using a long dated call spread with short dated put sales to reduce the position cost. Here is one such idea.
Use a close back below the last pivot at 12.45 as the SU (stop/unwind) or be prepared to take the stock by assignment in the event it closes below 14 on the September expiration. If so then the plan is to sell calls against the stock position. If the October put expires out-of-the-money then sell the November 14 put and then once again in December reducing the call spread cost each time. 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.   Experience an Options Specialist Try us with 50 Free Trades! optionsXpress   Summary With Friday's breakdown, the current trend for the euro is lower and if recent correlations remain unchanged, the rising dollar will pressure both equities and commodities. There is a good chance of comments or announcements over the weekend that could attempt to soothe market apprehension before the opening on Monday.

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