« October 2011 »

IVolatility Trading Digest™

Volume 11, Issue 39
Occupy Wall Street

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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In addition to concerns about how the Europeans led by Germany are going to save the Eurozone, we now have to consider a further degree of instability due to the protesters camped out in Zuccotti Park in Manhattan campaigning against social and economic inequalities in American life. 

We have one brief observation to add in the Strategy section below before turning our attention to making trading suggestions for those who may be looking for a way to join the ranks of the Wall Street.




StrategyThe Occupy Wall Street protesters say they are angry about the 2008 Wall Street bailout that they say allowed banks to reap huge profits while average Americans suffered high unemployment and job insecurity. While the smoke had been simmering for several weeks, Bank of America added gasoline to fire with its recent announcement that they intended to begin charging account holders $5 per month when they used their debit cards. Bank of America's poor timing is only exceeded by its previous decisions to acquire Countrywide Mortgage and Merrill Lynch.  

S&P 500 Index (SPX) 1155.46. After breaching 1100 last Tuesday, SPX made another classic reversal, like the one it made on August 9, and returned into the range that is now defined by the August 31 high at 1230.71 and the new low of 1074.77 made last Tuesday. Technical analysts will now start anticipating the formation of a Head & Shoulders bottom on the next test of support, which due to time symmetry could be about a month away.  

Our day-weighted VIX futures indicator closed the week back in positive territory with a premium to cash of 1.24% compared to last week's discount of -5.98%. For this short-term indicator the premium to the cash is a SPX sell signal suggesting professional expectations for the cash to advance toward the futures price.

As for copper, often called the best economic forecaster in the business, it tested $3.00 per pound, basis December futures, on Monday October 3, by trading as low as 2.9940 and then made a key reversal to close at 3.1505. It then continued higher to close the week at 3.2735 on the strongest three-day rally in a year. At the London Metals Exchange Week, Codelco, the world's largest copper producer, said they were expecting prices to range between $3.00 and $4.00 as its customers were seeking similar volumes of metal on annual contracts. With this reversal we advise closing the FCX November 29.50/23 put spread hedge suggested in Digest Issue 38 last week. We have a replacement long trade idea below.


Trade Review

CBOE Volatility Index® (VIX) 36.20.

In last week's Digest Issue 38, we suggested a calendar spread, long the November 40 call and short the October 40 call. At the close last Monday, we book the options spread with for a credit of 1.15 as the futures spread between to October and November widened to 4.50 from 4.40 the previous Friday.

As the VIX declined the spread between the two futures narrowed to close last week at 2.00. Marking to market the options spread suggestion on Friday its value had risen from the credit of 1.15 to a debit of .80, for a one-week gain of 1.95. Since the October call will continue to decline faster than the November call, as the VIX declines, we suggest keeping this one open until the VIX reaches 30.


Copper Turns

Freeport-McMoRan Copper & Gold Inc. (FCX) 34.01

Here is the long replacement for the copper hedge trade in Digest Issue 38.

The current Historical Volatility is 64.14 and 53.86 using the Parkinson's range method, with an Implied Volatility Index Mean of 60.99, down from 79.50 last week. The IV/HV ratio is .95 and the put-call ratio at .50 is slightly bullish. Friday's option volume was 101,794 contracts compared to the 5-day average of 101,610 contracts. The call volume accelerated in the last three days after copper's key reversal.



At 29% of the distance between the strike prices, this is a reasonably priced call spread combination with a decent volatility edge in the put. Use a close back below the previous pivot at 28.85 as the SU (stop/unwind).


Quarterly Report Season

Since quarterly reporting for DJ Industrials begin this week, we have a suggestion.

Alcoa Inc. (AA) 9.71. 

After a long decline from around 16 when it last reported we think it is likely oversold and could rebound if it can report better than the expected .21 per share on Tuesday after the close, since expectations have been lowered.

The current Historical Volatility is 54.09, and 43.66 using the range method, with an Implied Volatility Index Mean of 64.23, down from 68.30 last week. The IV/HV ratio is 1.19 and the put call ratio is very bullish at .3676. Friday's options volume was 53,145 contracts compared to the 5-day average 81,570 contacts. Consider this long call spread with a short put combination.



After reporting, we expect the implied volatility to decline. Use a close below the last pivot at 8.45 as the SU (stop/unwind) or be prepared to take the stock by assignment if it closes below 9 at the November expiration.


Stock Trend Analysis

Direct from the "Options Data Analysis" and the “Rankers & Scanners” sections of our home page we offer this "Stock Trend Analysis" suggestion as a regular feature. The selection criterion includes an Exponential Moving Average, Relative Strength Index and the Chaikin Money Flow Indictor and more. Here are more details for the Stock Trend Analysis selection process. On Friday, JCP was our top ranked selection with a 66.67% bullish rank. Consider this call spread, short put combination.

J. C. Penney Company, Inc. (JCP) 28.93. JCP operates department stores in the US and Puerto Rico.

The current Historical Volatility is 44.44, and 45.11 using the range method. The Implied Volatility Index Mean is 53.00, down from 59.25 last week, for an IV/HV ratio of 1.19, but 1.17 using the range method. The put-call ratio is bearish at 3.10. On Friday's option volume was 16,663 contracts compared to the 5-day average volume of 15,490 contracts. Consider this call spread, short put combination.



Use a close back below support at 25 as the SU (stop/unwind).


Takeover File Update

Yahoo! Inc. (YHOO) 15.47. YHOO is a digital media company in the process of reorganizing or perhaps being sold. The stock price is up on news that Jack Ma and others including Microsoft may be interested in the company as they explore the possibility of selling their interest in Yahoo Japan. Earnings are expected on October 18 with .17 per share consensus and a .16 whisper number.

The current Historical Volatility is 56.78, and 46.96 using the range method. The Implied Volatility Index Mean is 70.91, up from 69.33 last week, for an IV/HV ratio of 1.25 but 1.51 using the range method. The put-call ratio is bullish at .40. On Friday, there were 2.5 times more calls traded than puts and there were 13 call strikes with more than 2,000 calls traded. The call open interest exceeds the put open interest by more than two times.

Here is a call spread combination updated for the higher prices, but otherwise similar to the ones suggested in Digest Issue 35 and Digest Issue 37.



Use a close back below the last pivot at 13 as the SU (stop/unwind) or be prepared to take the stock by assignment in the event it closes below 14 on the November expiration. If so, then the plan is to sell calls against the stock position. If the November put expires out-of-the-money then sell the December 14 put and then once again in January reducing the call spread cost each time.

Here is another with unusual call volume that may be suggesting something is going on.

McDermott International Inc. (MDR) 13.95. MDR is an engineering, procurement and construction company focused on offshore oil and gas projects.

The current Historical Volatility is 88.28, and 69.87 using the range method. The Implied Volatility Index Mean is 92.30, up from 79.04 last week, for an IV/HV ratio of 1.05 but 1.32 using the range method. The put-call ratio is bullish at .18. On Friday, the October 15 call traded 5,605 contracts with an implied volatility of 99.44, suggesting they were bought at the offer price since the call implied volatility average was 91.46. Consider this idea.



Use a close back down below the last pivot at 10 as the SU (stop/unwind).


Highest IV/HV Ratio

Rambus Inc. (RMBS) 14.72. Rambus, one of the companies holding semiconductor patents, is involved in a lawsuit with Micron, Hynix and Nvidia. It seems the primary business of this company is intellectual property lawsuits.

The current Historical Volatility is 56.29, and 51.92 using the range method. The Implied Volatility Index Mean is 161.91, down 188.19 last week, for an IV/HV ratio of 2.88 and 3.12 using the range method. The put-call ratio is just bullish at .40. Friday's options volume was 14,257 contracts compared to the 5-day average of 15,480 contracts. The call open interest exceeds put open interest by more than two times.

The implied volatility started rising dramatically in the middle of September as the stock price rose above 12. Since the high-implied volatility indicates the potential for a large stock price move, we suggest selling a 12 put, as there is good previous support at this level.



Since there could be a sudden stock price move on legal news, the only practical risk management is to limit the position size and be prepared to take the stock by assignment in the event it closes below 12 on the October expiration.  

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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After testing and briefly breaching support the major equity indexes have returned to their recent ranges, however any negative news from Europe could cause them to decline once again. Volatility is likely to remain at elevated levels until there is a clear definition as to how the European debt problems are going to be resolved.


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In next week's issue, we will include a complete review of our market indicators along with more trading ideas.


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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Does anyone hedge VIX options other than using VIX futures?

Posted by J French on October 11, 2011 at 12:40 PM EDT


Thanks for the VIX question. If you are asking about hedging the VIX there are both futures and options on the futures used for hedging. They are usually used to hedge long stock portfolios since the VIX volatility measures are considerably higher than the stock indexes they are hedging. We display the VIX futures on Advanced Futures while the options are found in Advanced Options.


Posted by Jacktrader ( on October 12, 2011 at 08:00 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".