« November 2011 »

IVolatility Trading Digest™

Volume 11, Issue 44
Seasonal Strength

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Although still being battered by occasional downbeat news coming from Europe equities continue to show encouraging seasonal strength especially noticeable in those companies and indexes related to crude oil, gold and technology. Despite the headwinds coming from Europe, we think the chances are quite good the current strength will continue through year-end.      

After reviewing our market indicators and a brief strategy comment, we have one update followed by three new trade ideas.


Market Review

S&P 500 Index (SPX) 1263.85. Even after taking a 3.67% hit on news from Europe last Wednesday SPX continues working higher having built considerable support at 1225. We are continuing to use the breakout from the range as the active pattern with the measuring objective determined by the vertical height of the range it broke away from or about 156 points, up to 1387. First, it appears to be in the process of forming a classical symmetrical triangle consolidation pattern, which could propel it up near the July 7 resistance high at 1356.48.

E-mini S&P 500 Futures (ESZ1) 1261.50. Based upon the preliminary CME report Friday's volume was 1.6 million contracts, substantially below the recent average, but expected with the bond market being closed for the Veteran's Day holiday. We are now expecting volume to increase if it breaks out above the upper boundary of the forming symmetrical triangle consolidation pattern.

S&P 500 Index Implied Volatility (IVXM). Since our last market review, in Digest Issue 42, the Implied Volatility Index Mean increased from 21.54 to 25.60, while the CBOE Volatility Index® (VIX) increased from 24.53 to 30.04.

The table below shows the VIX Cash compared to the next two futures contracts as well as our calculation of Larry McMillan's day-weighted average between the first and second months.



The day weighting applied 10% to the November contract and 90% to December resulting in the average premium of .28 or .93% shown above.

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. Last week it was also at a premium of .77%, compared to premium of 5.87% in our last market review in Digest Issue 42 based upon October 28 closing prices. We note recent reversals have been associated with higher readings, both positive and negative.

Since the CBOE updates the VIX futures term structure during the day an estimate of the current premium or discount is always available. 

VIX Options

With a current 30-day Historical Volatility of 162.32 and 90.00 using Parkinson's range method, the table below shows the Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon the closing option mid prices on Friday along with their respective month's futures prices, since the options are priced from the futures.



Using the IV Index Mean of 102.00, the IV/HV ratio is .63, using the range method for Historical Volatility the ratio is .88 while the VIX put-call ratio at .50 is bearish for the S&P 500 Index.

All of the Implied Volatilities along with the Historical Volatilities and Greeks for the VIX options based upon the Futures prices can be found on our Advanced Options page by clicking on the "market close" link shown near the top of the page.

CBOE S&P 500 Skew Index (SKEW) 124.56. When out-of-the money S&P 500 Index puts are purchased for downside protection, the SKEW is designed to increase. From our perspective, the SKEW has been acting like a contrary indicator.

US Dollar Index (DX) 76.95. Boosted once again by flight from the euro DX retreated slightly on Friday, as the news from Europe was a bit more positive. Since the euro is currently the driving force for equities the CurrencyShares Euro Trust (FXE) 137.00 could be used to trade or hedge the markets, but we think there are better opportunities with volatility edge using options on other underlying stocks and ETFs.

iShares Barclays 7-10 Year Treasury (IEF) 103.69. The 10-year note, with a yield of 2.05 is down from 2.30% that we reported in Digest Issue 42, as IEF has now begun to trade in narrow range around 104, but remains below the broken upward slopping trendline from the July low. Based upon the IEF trendline from July the 10-year interest rates appear to be headed higher.

iShares Barclays 20+ Year Treasury Bond (TLT) 115.65. Long bonds are now yielding 3.11%, down from 3.35% in Digest Issue 42. Some technical analysts claim there is an active Head & Shoulders Top pattern on the December T-Bond futures chart. If activated with a close below the neckline it would have the potential to take long bonds back to 95 with a yield of 4.25%, however first it will have to overcome the Fed's operation twist to reach this level.  

NYSE McClellan Summation Index 747.63. Since Digest Issue 42, this NYSE breadth measure increased another 200.77 points, putting it back near the previous high reached on February 18 at 826.53, when the NYSE Composite was 8507.90, compared to Friday's 7576.18. This breadth measure is now higher than NYSE Composite Index was before the July decline as breadth continues to improve faster than the index. This is one reason we believe equities will continue higher through year-end. We encourage you to click on the link above and look at the chart showing improving breadth.  

iShares Dow Jones Transportation Average Index (IYT) 88.96. The transports are trading in line with the S&P 500 Index with both showing signs of making consolidation patterns and IYT appears to have already closed above the upper boundary of the symmetrical triangle. Presuming it continues higher this will be very positive from a Dow Theory perspective.

iShares S&P GSCI Commodity-Indexed Trust (GSG) 34.17. Since this index has made multiple closes above the downward sloping trendline from the May 2 high at 39.18, we can now identify a new upward sloping trendline from the October 4 low at 29.02, touching the November 1 low at 32.32. This is consistent with seasonal strength in both crude oil and gold. The crude oil strength is reflected by the WTI futures term structure that is now in backwardation by -.36 based upon the 90-day roll.



StrategyWhile crude oil trending is higher the same cannot be said for natural gas as it continues lower on warmer than usual winter weather forecasts. This is not positive for the large oil and gas companies with significant natural gas operations.

With seasonal strength being reflected in crude oil, gold and technology we suggest long positions in these sectors that allow for continuing sporadic rapid declines on more bad the news from Europe. In the event the news turns more favorable, position size can easily be increased. 

Many companies are still scheduled to report third quarter earnings and we have one interesting idea in this category below right after an update.


Here is the result of an unusual long put spread from a suggestion we made in Digest Issue 41 and then reaffirmed again the Digest Issue 43.

Green Mountain Coffee Roasters Inc. (GMCR) 43.71. This company in the specialty coffee and coffee maker business reported .47 per share last Wednesday while the estimate was for .48 per share. On Thursday, the stock gaped lower and closed down 26.13 after reporting declining revenue, and we suspect it was also related to the previous high valuation, along with their heavy emphasis on non-GAAP accounting and the large short interest. 

In Digest Issue 41, we suggested a long December 60 put with a short December 50 put spread. We booked the suggestion for a 2.02 debit. On Friday, the spread closed at 8.42 and since there now appears to be some short covering we suggest closing it out and booking the 317% gain. 


Quarterly Earnings Report

Salesforce.com (CRM) 129.87. CRM offers a technology platform for customers and developers to build and run business applications and provides customer relationship management (CRM) services to various businesses and industries worldwide.

They are scheduled to report third quarter earnings on Thursday after the close. The consensus estimate is .31 and the whisper estimate is .33, while the estimate based upon GAAP is .03. Yahoo! Finance show the price-to-earnings multiple based upon GAAP earnings of 634 with the forward earnings price-to-earnings multiple of 73 and a price-to-earnings growth ratio at 4.17. This is another company relying heavily upon non-GAAP accounting to report its progress.

The current Historical Volatility is 46.83 and 41.32 using the Parkinson's range method, with an Implied Volatility Index Mean of 66.84, up from 64.42 last week. The IV/HV ratio is 1.43 and 1.62 using the range HV. The put-call ratio at 1.50 is bearish. Friday's volume was 21,095 contracts compared to the 5-day average of 16,480 contracts. 

Since the stock is in the upper part of a 110-140 range an iron condor was considered, but the long put part of the combination is too expensive in implied volatility terms, so here is the upper call half of an iron condor with a far out-of-the money short put combination as an alternative.



Since the options expire on Saturday November 19, there is only one day of trading after they report earnings so this one will require immediate attention. In the event the stock closes below 110 on Friday, be prepared to take the stock by assignment and then sell a call against the long stock. In this event, the basis in the stock will be 107.43 and below previous support at 110. On the other hand, if the stock trades higher than 140 after reporting close the short call spread.

Las Vegas Sands Corp. (LVS) 46.37. Last suggested in Digest Issue 31, LVS operates casinos in Las Vegas, Macau, and Singapore. LVS reported .55 per share on October 27 and the stock rose to just below 50 before retreating in what appears to have been a post earnings sell off. Then on Friday, it turned up once again.

The current Historical Volatility is 57.46 and 46.57 using the range method, with an Implied Volatility Index Mean of 45.66, down from 46.07 last week. The IV/HV ratio is .79 and .98 using the range method HV. The put-call ratio at .45 is bullish. Friday's volume was 50,204 contracts compared to the 5-day average of 49,980 contracts. This is a well-managed company and we want to take advantage of the still relatively high-implied volatility that is now trending lower. Although without volatility edge, consider this put sale as post- earnings reversal trade.



Be prepared to take the stock by assignment in the event it closes below 45 on Friday. In that event, the plan is to sell calls against the stock position.


Seasonal Crude Oil

It has been a long time since the WTI futures term structure has been in backwardation, when the deferred contacts are selling at lower prices than the near term contracts. Usually this is associated with rising prices and indicates near term demand is high. As we noted in the (GSG) section of the market review the 90-day roll is -.36 lower than the cash. If this continues, there is an edge when the near term contracts expire and they are rolled into to the next month. Based upon the strong current uptrend and the backwardation consider this idea.

Dave's Corner

Flat Skew Makes Upside on USO Attractive

United States Oil Trust (USO) 38.21.

The demand for oil during the past two months has increased and now many market pundits are suggesting $100 dollar oil prices look likely.

The US Department of Energy released their weekly inventory report reflecting higher demand especially for distillate fuel such as diesel and heating oil. A large inventory drawdown for distillate fuel has put a drain on availability as inventory levels are at the bottom end of the range for this time of year. Distillate demand increased by 4%, and could create a significant imbalance moving into the winter for US fuel oil customers.

Despite the increase in demand, the USO has not yet broken technical resistance around 39. A break above the 50-day moving average near 37.70 was positive, but USO needs to clear the recent highs near 39.50. A close above this level could lead to a test of resistance near the 200-day moving average near 47.00.

The current Historical Volatility is 30.89 and 26.28 using the range method, with an Implied Volatility Index Mean of 39.60, up from 38.55 last week. The IV/HV ratio is 1.28 and 1.51 using the range method HV. The put-call ratio at .40 is bullish.

A call spread on USO would take advantage of an upside breakout, while providing a defined risk.



Use a close back below support at 36 as the stop.

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.



The combination of improving market breadth along with seasonal strength has improved the outlook for equities going into the year-end despite continuing expectations for more negative news from Europe. In the event there is some good news from Europe, the pace of advance, for both equities and commodities will most likely increase.


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In next week's issue, we will crank up our ranker and scanner tools to find 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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I think there is an error in your suggestion regarding USO. The short leg of the trade should be a CALL not a PUT.

Thank you for the insightful suggestions and commentary, as always.

Posted by HM on November 13, 2011 at 06:40 PM EST


Thanks for the comment. You are right, somehow this slipped by our editor. It is fixed now.


Posted by Jacktrader ( on November 15, 2011 at 01:41 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".