« April 2012 »

IVolatility Trading Digest™

Volume 12, Issue 14
April Potpourri

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Since we are going to cover a bit more territory than usual in this Digest, we will be omitting some of the option detail we normally include along with the trade suggestions. We begin with a strategy review along with an update for last Thursdays' tweet followed by an earnings report suggestion. Then we have two short ideas along with three more in the Takeover File. We begin with some strategy comments.  



StrategyS&P 500 Index (SPX) 1408.47. Last Tuesday's high of 1419.15 created a new upside resistance target. It is especially important since it needs to close above this level to negate the small Head & Shoulders pattern that is now a possibility.

On the downside, the first support is 1378.04 from February 29, which would also be below our upward sloping trendline that began with the November 28, 2011 low at 1169.29 and below the neckline of the small potential Head & Shoulders pattern mentioned above. Should it reach support at 1378.04, the trend will have changed. In the meanwhile, the VIX futures premium is back into normal territory. Here is the update.

S&P 500 Index Implied Volatility (IVXM). Since last week, the Implied Volatility Index Mean increased from 12.84 to 13.35, while the CBOE Volatility Index® (VIX) increased from 14.82 to 15.50.   

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 applies 60% to April and 40% to May resulting in the average premium of 2.18 or 14.06% shown above. Our alternative volume weighting between April and May results in a 13.44% premium. Both measures are back into the normal range.  

In addition, open interest declined from 320,215 to 292,427, comparing Thursday to the previous week. By the end of the week, it appeared the VIX hedge was no longer going to be required so we have an update comment below.

While the VIX futures are implying a more positive outlook, we think there are three other things needed for the current uptrend to continue.

  1. The SPX needs to close above 1419.15, last Tuesday's high.

  2. Help from the transports, which have stalled due to the high price of crude oil and gasoline, which is possible since crude oil looks like it is starting to correct.

  3. A resolution to the NYSE advance-decline divergence by more issues advancing compared to those declining.



Last week in Digest Issue 13, we suggested a VIX futures hedge plan using the April 17 call option. Since the SPX closed higher last Monday and the VIX declined by .56 the plan was suspended. However, with Thursday's decline, as the April future increased to 18.80, we sent a tweet suggesting implementing the hedge using the April 19 call option. By the end of the week, the futures turned lower and the premium to the VIX cash declined, so we no longer suggest holding this option. While the VIX futures look as if they are turning higher, we will need to see the premium increase before suggesting another hedge idea.

High IV/HV Ratio Earnings Suggestion

Chipotle Mexican Grill, Inc. (CMG) 418.00. This fast-casual fresh Mexican restaurant chain is currently selling at 62 times 12 month trailing earnings and 39 times forward earrings with an estimated 2.22 price-to-earnings growth ratio. Scheduled to report 1Q earnings on April 19 after the close, the consensus estimate is 1.92 per share. The options implied volatility has been rising and it is likely to accelerate as the report date approaches. Ranked number one on Friday, it had an IV index mean of 28.99 and a 12.66 Historical Volatility for a ratio of 2.29.

The financial media and some analysts are beginning to wonder if the momentum has stalled so the uncertainty going into the earnings report is likely to increase. If so, the plan is to buy a straddle and sell it on April 19, after confirming they still plan to report earnings after the market close. Noteworthy, April 19 is one trading day before the April options expire. Although expensive in dollar terms here is the suggestion.



Close the straddle April 19. In the meanwhile, watch to see if it begins to sell off before the report date. If so a May put spread could also be considered before the earnings report.

Short Ideas

United States Oil (USO) 39.23. If crude oil prices are going to continue declining, we have a ratio backspread to consider that will benefit from an increase in implied volatility as it declines. In addition, since the futures are in contango it costs to roll them into each next month. 



The July 35 puts were .93 each with vegas of .0656 for the combined totals above. Use a close back above the 41 resistance as the SU (stop/unwind).

Sears Holdings Corporation (SHLD) 66.25. We last suggested a short strategy in Digest Issue 2, just before a short squeeze began pushing the stock higher. Following our trade plan, we would have closed the put spread as the stock closed above 37.90 on January 19. Now we return after the stock closed below the upward sloping trendline from the January low along with signs that the short squeeze is over and news the company is liquidating more assets to meet is cash needs. It seems like a company in liquidation that is losing money should not be selling at 66 and certainly not at the recent the recent price of 85. Here is another ratio backspread idea since we think the implied volatility will increase as the stock continues to decline.



The June 55 puts were 3.68 each with vegas of .0936 for the combined totals above. Use a close back above the last pivot at 75 as the SU (stop/unwind).


Takeover File

It has been awhile since we updated the Takeover File, but with new activity, it gives us a chance to review some of them and add the newest entry.

Amylin Pharmaceuticals, Inc. (AMLN) 24.96. Bloomberg reported Bristol-Squibb Myers (BMY) approached them with a $3.5 billion offer or 22 per share, which apparently has been rejected.

While additional details have not been released at least one analyst thinks the 22 per share offer is too low and will be outbid since AMLN's diabetes drugs would be attractive to a number of other large drug makers and specialty pharma companies.

The current price suggests the 22 bid is too low, but who knows if another bidder will enter the contest. In the meanwhile, here is a call spread short put combination that allows enough time for more details and commentary to emerge.



Since it could take quite some time for this to be resolved there could be more opportunities to sell puts with high-implied volatility thereby reducing the cost of the spread. The risk is a close below 20 at the May expiration. In that event, be prepared to receive the stock by assignment.

Collective Brands, Inc. (PSS) 19.66. Although not featured in previous Digest issues here is one we have been watching since late January. Last August the operator of Payless and Stride Rite shoe stores announced they were closing 475 stores and launching a strategic review of its business to increase shareholder value.

Thursday reports circulated that a South Korean newspaper was reporting E-Land Group, a South Korean company, is preparing a $1.8 billion offer for Collective Brands. It said E-Land is working with institutional investors to raise the money, including working with the National Pension Service and the Korea Development Bank expecting to make an official bid in April. Collective Brands, based in Topeka, Kansas declined to comment.

With 60.62 million shares outstanding, the current price implies the company is valued around 1.19 billion. If they do offer $1.8 billion as reported, it would represent a 50% premium to the current price.  

With a current Implied Volatility Index Mean of 39.38 and a Historical Volatility of 33.05, here is a put sale suggestion at the current support level.



In the event of a close below 18 at the May options expiration be prepared to receive the stock by assignment. In that event, the next support is around 16 so the plan would be to sell calls against the long stock while waiting to see what other alternatives they can find to increase shareholder value. 

Illumina, Inc. (ILMN) 52.61. In Digest Issue 7, we said the Roche bid at 40, followed by a public offer at 44.50, was not being taken seriously since the option implied volatility declined to around 20.

In the last week the implied volatility has risen to 45 suggesting something new was about to happen. On Thursday, Roche increased the bid to 51 per share and by the end of the week, the implied volatility declined to 37.94, but the put-call ratio at .3 was very bullish along with 36,262 option contracts traded Friday compared to the 5-day average of 29,420 contracts.

In addition, there were reports that the second largest shareholder with an 11% stake is opposed to the deal.

Although Friday's volume was higher than the average, implied volatility is not rising as much as it should if a deal is in the near future. In addition, the bid/ask spreads are unusually wide suggesting  uncertainty.

Nevertheless, here is a suggestion to consider using the unusually wide option bid and ask prices.



Use a close back below 50 as the SU (stop/unwind).

All of the suggestions above, except for Illumina 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 additional option details including the Greeks are available on our website.


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While the VIX futures premium pressure continued declining last week there are still some important concerns preventing an all clear signal for equities. However, if crude oil continues lower it could quickly improve the outlook.


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In next week's issue, we will review and update all of our indicators with special attention given to crude oil.


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. Another way to find them is the Table of Contents link in the blog section of our website.

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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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".