« April 2012 »

IVolatility Trading Digest™

Volume 12, Issue 18
Bell Ringer

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Those who have been following our comments in the Digest for the last few weeks know one of the reasons we have been urging caution and more hedging was due to the deteriorating breadth or the number of advancing issued compared to the declining issues on the New York Stock Exchange. Last week it changed and for the first week in the last ten, breadth improved. This is a bell ringer.

Along with the improving breadth, the major indexes also advanced enough to begin questioning the potential Head & Shoulders Top that we have been watching. We have more in the strategy section below along with two updates, a best trend suggestion, two new longs and several more in the takeover file update.



StrategyS&P 500 Index (SPX) 1403.36. While declining near the April 10 support low at 1357.38 it did not close below before rebounding. Now back above 1400 it begins to looks as if the once potential complex Head & Shoulders Top pattern could be morphing into a symmetrical triangle continuation pattern. While we still need to see a close above the April 2 high at 1422.38 to rule out the Head & Shoulders Top pattern entirely, it now looks less likely.

NYSE McClellan Summation Index 193.52. With a gain of 53.87 points, the first in ten weeks, this is our bell ringer for improving market breadth, a necessary condition for the market to continue advancing. Click on the link above and look at this important breadth indicator.

Next, our VIX futures premium indicator increased only slightly to 15.75% from last week at 14.85% as the day weighting applied 60% to May and 40% to June. Our alternative volume weighting between May and June resulted in a 15.51% premium.

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. In the past premiums in excess of 20%, have usually preceded corrections, although not a precise timing tool it does appear to be a good way to measure professional hedging sentiment. We consider the current readings to be about neutral. 

Since equities appear to be improving and maybe about to resume their uptrend from last October we suggest removing any remaining hedges and start adding long positions once again.





Apple Inc. (AAPL) 603.00.

After reporting better than expected 2Q earnings on Tuesday April 24, it closed up 30.02 for the week.

Our follow the leader calendar spread suggestion in Digest Issue 17 was a loser since calendars short the near-term option will be losers if the underlying makes a large move. Compounding the loss amount was the high priced underlying stock.  

Following the plan, we closed it Friday and booked the 10.20 loss.

Sears Holdings Corporation (SHLD) 54.33. The ratio backspread idea suggested in Digest Issue 14 needs adjusting. Although the stock declined as expected it now looks as if may attempt to turn higher going into the 1Q earnings report scheduled for May 24. On the last earnings report, the implied volatility index mean was near 110 and there is a good chance it will reach these levels once again. Accordingly, we will convert our ratio backspread into a long straddle with the plan to sell it before the report release. Here is the conversion trade. 



We buy 1 June 65 put to close and buy 2 June 55 calls to open resulting in a new 2 lot long June 55 strangle position since we still have the original 2 long June 55 puts from the ratio backspread.  

Stock Trend Analysis Suggestion

Direct from the "Options Data Analysis" and the "Rankers & Scanners" sections on our home page Friday we offer this "Stock Trend Analysis" suggestion as a regular feature for your consideration. The selection criteria include an Exponential Moving Average, Relative Strength Index and the Chaikin Money Flow indictor and more. Details are here.

PulteGroup, Inc. (PHM) 10.07. Using our stock trend analysis methodology, this homebuilder scored a 75% bullish rank on Friday.  

Accordingly consider this long call short put combination as a trend continuation idea.



The implied volatilities of the calls are near the 45.89 Historical Volatility of the underlying, but there is good volatility edge in the short put shown above at 58.18. Use a close below the recent pivot at 8.25 as the SU (stop/unwind).

Low Range Ideas

In the "Rankers and Scanner" section of our home page we feature the "Top 5 stock by implied volatility change."

Here are two interesting idea from the 52-week low implied volatility range section that look interesting.



Since both are quality companies with the low implied volatilities, this is an opportunity to use inexpensive long call spreads supplemented with short puts.

Takeover File

We have some new additions and update comments for the takeover file. While the investment bankers and lawyers are no doubt very busy working on these deals, their efforts are not yet reflected in unusual options activity.  

Avon Products Inc. (AVP) 21.57. AVP has rejected the offer to buy the company made by Coty, the French fragrance and global beauty company, at 23.25. The low options volume suggests there have been no further recent developments.   

The current Historical Volatility is 53.22 and 26.06 using the Parkinson's range method, with an Implied Volatility Index Mean of 43.74 down from 44.58 last week. The IV/HV ratio is .82 and 1.70 using the range method to calculate the HV. Friday's put-call ratio was bearish at 1.80 while the volume was 5,025 contracts traded compared to the 5-day average volume of 9,030 contracts.

Consider this long call spread with a short put combination.



There is good volatility edge in the May 21 put and if this drags out for a long time, it will likely expire worthless, providing the opportunity to sell another with June expiration. Use a close back below support at 20 as the SU (stop/unwind).

Human Genome Sciences Inc. (HGSI) 14.57. Human Genome's board of directors recently rejected GlaxoSmithKline's offer to acquire the company for 13 per share in cash, as they believe the offer price undervalues the company. Human Genome is currently evaluating alternatives regarding its future, including a potential sale. According the report, Glaxo has been invited to take part in the proceedings. So far, the options are not reflecting much enthusiasm for a higher price. 

The current Historical Volatility is 201.11 and 41.63 using the Parkinson's range method, with an Implied Volatility Index Mean of 40.64 down from 44.98 last week. The IV/HV ratio is .20 and .98 using the range method to calculate the HV. Friday's put-call ratio was on the bullish/bearish line at .70, while the volume was 7,622 contracts traded compared to the 5-day average volume of 24,320 contracts.

This one could also be a long drawn out affair. In the meanwhile, consider this idea.



For this one there is no good place for the stop anywhere near the current price level, so the only real risk management technique is to limit the position size.

Ardea Biosciences, Inc. (RDEA) 31.85. AstraZeneca plc announced it has entered into an agreement to purchase RDEA for a cash value of approximately 1.26 billion or 32 per share. Both the AstraZeneca and Ardea boards have unanimously supported the deal expected to close in second or third quarter of 2012, subject to certain regulatory conditions, including approval by Ardea's shareholders.

Since it appears uncontested and there are very few options trading, we do not see an options opportunity for this one.

Amylin Pharmaceuticals, Inc. (AMLN) 25.42. Apparently AMLN does not want anything to do with

Bristol-Myers Squibb and is seeking an alternative buyer.

The current Historical Volatility is 135.48 and 43.36 using the Parkinson's range method, with an Implied Volatility Index Mean of 46.69 down from 80.81 last week. The IV/HV ratio is .34 and 1.07 using the range method to calculate the HV. Friday's put-call ratio was bullish at .70 while the volume was 6,750 contracts traded compared to the 5-day average volume of 18,420 contracts.

Originally suggested in Digest Issue 14 here is another idea for those who may want to increase their positions.



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 June expiration. In that event, be prepared to receive the stock by assignment.


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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There was a significant improvement in the outlook for equities last week. The most noticeable was the long awaited upturn in market breadth. In addition, generally positive earnings reports are adding upside momentum and diminishing the chances for a near-term downturn in the major indexes.


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.


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Since we will be away attending the Options Industry Conference next week for our next issue we will review some of our trading concepts and update our volatility guidelines.


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".