« December 2011 »

IVolatility Trading Digest™

Volume 11, Issue 47
The Fed Takes Action

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

Last week, in a coordinated effort to lower the dollar funding costs for European banks the US Federal Reserve along with five other central banks lowered the three-month euro swap rate, allowing European banks to pay a lower premium to borrow dollars in the swap market. This action along with signals from China that their bank tightening cycle may be ending drastically changed market sentiment. We have more in the Strategy section below followed by five new trading suggestions to consider.



StrategyS&P 500 Index (SPX) 1244.28. Last week we were expecting to see a further decline in market sentiment before it would attempt to turn higher. Now with the coordinated action of the central banks and signals from China there is good chance the right shoulder of the Head & Shoulder Bottom has been defined, although there is still fundamental risk from Europe to consider. With the well-defined right shoulder, once it closes above the pattern neckline at 1,350, we have estimated the potential upside minimum measuring objective at 1,545.

As for our VIX futures premium, the day weighting applied 48% to the December contract and 52% to January resulting in the average premium of 1.37 or 4.99%. The alternative volume weighting between December and January results a 4.68% premium.

Although higher than last week's 1.11%, the still relatively low premium level probably reflects a lack of enthusiasm to push the VIX futures higher for portfolio protection.


Seasonal Implied Volatility

The seasonal tendency for equities to rise at the end of year is accompanied by a seasonal decline in implied volatility. Although implied volatility has already significantly declined, with some help from our friends in Europe, there could be more to come. If so here is an idea for a continuation of the year-end decline.

CBOE Volatility Index® (VIX) 27.52.

One strategy for an expected decline in market implied volatility is to use a put backspread, with long puts at a lower exercise price and a short put at a higher exercise price. Since this position is long more options than short, it should only be used when the implied volatility of the short put is higher that the long puts.

The current Historical Volatility is 150.71 and 81.01 using the Parkinson's range method, with an Implied Volatility Index Mean of 87.86, down from 101.29 last week. The IV/HV ratio is .58 and 1.09 using the more accurate range HV. The put-call ratio at .60 is normally somewhat bearish but for the VIX a higher ratio indicates less interest in buying VIX options for hedging making higher VIX put-call ratios bullish for the SPX. Friday's option volume was 368,150 contracts compared to the 5-day average of 290,130 contracts.

Since the last trading day for the December options is December 16 and before most of the holiday slowdown, we suggest using January put options.



The two Jan 25 puts were priced at 1.05 each for a 2.10 total as shown above.

Use a close back above 30 as the SU (stop/unwind).

Quarterly Earnings Report

As a regular feature on our home page in "Options Data Analysis" and the "Rankers & Scanners" sections of we offer the"Best Calendar Spread" based upon the differential between the implied volatility of the near term call compared to the implied volatility of the deferred month call. Often calendar spread ideas are identified going into earnings report dates as in last Friday's selection.

Best Buy Co. Inc. (BBY) 27.60. BBY is a retailer of consumer electronics, home office and entertainment products, in the United States, Europe, Canada, and China.

The 3Q earnings report is due on December 13 before the opening, with a consensus estimate of .50 per share and a whisper estimate of .52 per share.

The current Historical Volatility is 32.26 and 32.32 using the Parkinson's range method, with an Implied Volatility Index Mean of 43.21, down from 48.16 last week. The IV/HV ratio is 1.34 using both HV measures. The put-call ratio at 1.05 is in bearish territory most likely due to hedging activity before the earnings report. Friday's option volume was 8,224 contracts compared to the 5-day average of 13,320 contracts.

Consider this calendar spread idea.



Notice the difference in the implied volatilities. The last trading day for the December calls is four days after they report earnings. In the event the stock closes below 28 on the December expiration the plan is to then sell a January OTM call against the still long March 28 call.

High IV/HV Ratios

We offer a link to the Top 5 on our home page as a regular feature in the Rankers and Scanners section. High IV/HV ratios are the first alert that something unusual is happening as the options prices are being bid up to abnormal levels.

In the number two place from Friday's Top 5 IV/HV scan, we find one of our favorites that we have recommended in several past Digest issues, most recently in Digest Issue 45 when our RT Options Scanner found 8 call option series with more 2,000 calls traded.   

Yahoo! Inc. (YHOO) 16.05. YHOO is a digital media company in the process of reorganizing or perhaps being sold. Once again, this stock price is up on news that Jack Ma and others are working on a plan to acquire the company. Rumors have the price in the 18-20 range.

The current Historical Volatility is 35.32 and 25.99 using the Parkinson's range method, with an Implied Volatility Index Mean of 55.92, down from 62.31 last week. The IV/HV ratio is 1.58 and 2.15 using the range method to calculate the HV. The put-call ratio at .40 remains extremely bullish, as it has been for several weeks. Friday's option volume was 90,548 contracts compared to the 5-day average of 196,190 contracts.

Here is the strategy we have suggested several previous times with updated prices and with an updated expiration date for the put sale, but otherwise similar to the ones suggested in five previous Digest issues.



Use a close back below the last pivot at 15 as the SU (stop/unwind) or be prepared to take the stock by assignment in the event it closes below 15 on the January expiration. If so, then the plan is to sell calls against the stock position.

Here is number four from the Friday's Top 5 IV/HV scan list.

McMoRan Exploration Co. (MMR) 15.87. MMR operates in the shallow water of the Gulf of Mexico and onshore in the Gulf Coast area of the US, exploring for and producing natural gas and oil.

In the past week, the stock was up from 14 along with several other small Gulf of Mexico gas producers on news that some Gulf production had been closed due to weather.

The current Historical Volatility is 66.09 and 60.82 using the Parkinson's range method, with an Implied Volatility Index Mean of 95.56, down from 114.70 last week. The IV/HV ratio is 1.45 and 1.57 using the range method. The put-call ratio is favorable at .45. Friday's option volume was 20,842 contracts compared to the 5-day average of 20,970 contracts.

Here is an interesting put sale idea.



With a good implied volatility edge, we expect the implied volatility will decline back down toward the 70 level. In the event the stock closes below 14 at the January expiration be prepared to take it by assignment and then sell calls against the long stock position.

High-Implied Volatility Idea

Dave's corner

High Volatility Creates Iron Condor Trading Opportunity

InterOil Corp. (IOC) 54.75.

The energy sector experienced extreme volatility as the broader markets gyrated over the past three weeks. LNG Producers have also been benefitted by the recent large draws in distillate fuel as reported by the US Department of Energy.

On November 14, InterOil Corp. reported a third quarter loss of .44 per share on sales of 278.5 million, missing estimates by .36. Analysts expected a loss of .08 per share on sales of 329.7 million.  

The downdraft in price after the earnings report and the recent snap back from 45.52 to 55.64, created a surge in implied volatility. The bounce began after the company signed an agreement with Gunvor Singapore Pte. Ltd. to supply 1 million tons liquefied natural gas a year.

The price has fluctuated between a 52-week high of 81.92 and a 52-week low of 31.18 and has been range bound for the past 7 trading sessions above the 200-day moving average near 48, and below the 50-day moving average at 59. There is strong resistance near 65 while support is around 40.

The current Historical Volatility is 86.56 and 82.52 using the Parkinson's range method, with an Implied Volatility Index Mean of 133.19, up from 128.04 last week. The IV/HV ratio is 1.54 and 1.61 using the range method to calculate the HV. The put-call ratio is extremely bullish at .20.

Notice the implied volatility shown in orange in this chart while the Historical Volatility is blue.



As shown above, it looks as if the implied volatility could soon return to 75 and eventually even drop further toward 50.

An Iron Condor is a sale of a call spread combined with a sale of a put spread. The objective is to take advantage of the high-implied volatility, when a stock is in a defined trading range.

First the call spread.



Next the put spread.



When combined the two credits total 1.24.

The risk is $3.76, which is the difference between the strike prices of the sold spread ($70-65 or $40-$35) and the premium. This would occur if InterOil closed above 70 or below 35 at expiration of the December contract, just 10 trading days away.

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.

As the holiday season approaches, we are again offering special discounted rates on our data services. Here is more information about how to acquire your customized data service to help find those special volatility events and other advantageous trading ideas.



IVolatility’s Holidays Special Offer



After an impressive advance in the major equity indexes last week from the coordinated central bank efforts to lower interbank lending costs in Europe the sovereign debt crisis remains unresolved. If equities continue to advance from the levels obtained last week they will be encouraging leading indicators.


IVolatility.com Bookstore  In addition to the vast number of articles and other information on our web site, take a browse through our bookstore for more reference information and material.

Twitter Follow us on twitter for more ideas from our scanners and other developments.



In next week's issue, we will once again review our market indicators and offer more moneymaking ideas to consider.


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.

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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".