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Today


IVolatility Trading Digest™


Volume 12, Issue 40
More Volatility Kings

More Volatility Kings - IVolatility Trading Digest

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).

 

More Volatility KingsTwo weeks ago in Digest Issue 38 anticipating 3Q earnings reports that begin this week, we introduced Volatility Kings, our list of underlying stocks that in the past experienced significant increased options implied volatility going into their reporting dates. This week we add to the list those scheduled to report earnings in November.

We begin with a brief strategy comment followed by an update of our VIX futures premium. Then, our November Volatility Kings followed by four more suggestions for the regular October expiration: MetroPCS Communications, Inc. (PCS), Netflix, Inc. (NFLX), Questcor Pharmaceuticals, Inc. (QCOR), Amarin Corporation plc (AMRN)

 

Strategy

StrategyS&P 500 Index (SPX) 1460.93. The September employment report was just enough to keep the media supplied with new controversial material, but not enough to reverse the near term uptrend. The challenge now is the September 14 resistance high at 1474.51 where we suspect it will encounter some selling.

In the absence of negative news from Europe, that could upset the best-laid plans of mice and men, chances are the markets will now start focusing attention on 3Q earnings reports.

Then, between now and year-end we continue to think another important influence will be underinvested mutual and hedge funds chasing performance since they risk the loss of assets under management if their year-end performance lags the S&P 500 Index. With some additional help from declining crude oil prices, which will help the important transportation sector, we think the S&P 500 Index could reach 1500 by the end of the year.

S&P 500 Index Implied Volatility (IVXM). At the end of last week, the Implied Volatility Index Mean had declined from 12.89 to 11.96, while the CBOE Volatility Index® (VIX) declined from 15.73 to 14.33.

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.

 

VIX Closing Cash

 

The day weighting applied 35% to October and 65% to November resulting in the average premium of 2.38 or 16.62% shown above. Our alternative volume weighting between October and November is a 15.00 % premium. Last week the day-weighted premium was 8.35% and the volume weighted was 8.63%. Fridays' volume was 120,720 contracts with an open interest of 407,720 contracts compared to 103,032 and 384,291 contracts the Friday before. Open interest peaked at 429,193 contracts on September 14, just before the September expiration as contracts rolled over.

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 appears to be a good way to measure professional hedging sentiment, which is now back into the normal range.

 

November Volatility Kings

 

MDR,GMCR,MELI,WFM,CRM,MCP,NVDA,SD,SHLD,CTRP,JCP,GRPN,NTAP

Est Date needs verification since they vary depending upon the source
IVXM is Friday's Implied Volatility Index Mean
IVXM Est is the estimated Implied Volatility Index Mean it could reach by the next report date using a volatility chart.
IV Est/IV is the ratio between the current implied volatility and the expected implied volatility at the report date.

 

As we explained in Digest Issue 38, straddles or strangles are two alternatives to use going into the reporting dates with plans to close them just before the report. The estimated implied volatility at the report date is a guideline based upon the most recent reports and may not be relevant in the current quarter. The actual reporting dates need scrutiny since they vary by the data source and are subject to change by the reporting companies.

Implied volatility reflects uncertainty or the width of the possible stock price distribution. While these companies have experienced increasing implied volatility when they previously reported, the level of uncertainty for the current report may not be comparable. Indeed some companies are on the list one quarter and not the next while others remain quarter after quarter.

Since the list is constantly changing, we can use your help identifying new candidates. If you have suggestions for additions please let us know.

 

Takeover File

In addition to being a new entry in the Takeover File, this company also ranked number one in Friday's positive IV Change scan.

MetroPCS Communications, Inc. (PCS) 12.65.

Just as PCS and Deutsche Telekom AG, the parent company of T-Mobile, settled upon a merger deal, rumors began circulating that Sprint Nextel Corp. (S) 5.20 may also have an interest. Since the shareholders and regulators must approve the merger, any Sprint involvement would delay or even scuttle the proposed PCS/T-Mobile deal.

The option data follows.

The current Historical Volatility is 65.81 and 64.47 using the Parkinson's range method, with an Implied Volatility Index Mean of 76.45 up from 62.59 last week. The IV/HV ratio is 1.16 and 1.19 using the range method to calculate the HV. Friday's put-call ratio was a bearish 1.25, while the volume was 268,692 contracts traded compared to the 5-day average volume of 135,950.

Since the options expiring on October 20 are elevated the October 12 put looks like a very interesting sale, but then so does the October 12 call since we do not think there will be any resolution in the next two weeks. Accordingly, we suggested selling both and then hedging them with a long February straddle.

First, the October 20 options adjusted for the estimated weekend time decay,

 

PCS October

 

Next the February options,

 

PCS February

 

At the October expiration, one or the other option will be in-the-money. If it is the put, which seems unlikely take the stock by assignment and then sell a call in November. If call is in-the-money be prepared to buy stock before the close on October 19 to cover the short call that will be assigned. In the event Sprint does become involved, there could be many months of trading around the long February straddle.  

Active Options

Here is one included in our October Volatility Kings list in Digest Issue 38 with active Friday call volume.  

Netflix, Inc. (NFLX) 66.56.

The current Historical Volatility is 55.70 and 42.26 using the Parkinson's range method, with an Implied Volatility Index Mean of 67.96 up from 61.99 last week. The IV/HV ratio is 1.22 and 1.61 using the range method to calculate the HV. Friday's put-call ratio was just bearish at .80, while the volume was 84,654 contracts traded compared to the 5-day average volume of 78,380.

Scheduled to report earnings on October 23, after the close, the consensus estimate is .05 per share.

Up 22% this week on upgrades from both Citigroup analyst Mark Mahaney and former bear Whitney Tilson. Mahaney reiterated his buy rating and 120 price target, citing improving customer satisfaction, which seems odd citing improving customer satisfaction as the upgrade justification coming this soon before the earnings report, which leads us to wonder if Mahaney knows more than he is saying.

If so, we suggest going with the flow by using a short-term call spread that will expire before the report date since the implied volatility for the October options that expire before the report date are a good bit lower than the November options that expire after the report. For example, the October 65 straddle has an implied volatility of 50.62 while the November is 71.71.

Here is the call spread using the October options adjusted for the estimated weekend time decay

 

NFLX October options

 

Use a close back below support at 60 as the SU (stop/unwind).

IV Change

Friday, we had an interesting biotech in the number two scan spot for increasing implied volatility.

Questcor Pharmaceuticals, Inc. (QCOR) 19.40. After news that Aetna took away reimbursement for the company's flagship HP Acthar Gel the stock dropped 48% on September 19. However, other insurers say they will cover the gel and the stock has stabilized at just under 20.

While we do not know any more about the drug or its futures prospects, we know something about high-implied volatility and options volume.

The current Historical Volatility is 238.01 and 158.65 using the Parkinson's range method, with an Implied Volatility Index Mean of 107.85 down from 110.60 last week. The IV/HV ratio is .45 and .68 using the range method to calculate the HV. However, the 10-day range HV is 85.90. Friday's put-call ratio was a bearish 1.35, while the volume was 30,728 contracts traded compared to the 5-day average volume of 14,930.

Here is an October put sale idea with the price adjusted for the estimated weekend time decay.

 

QCOR October put sale idea

 

In the event it the stock closes below 16 at the October expiration in two weeks be prepared to take the stock by assignment and then sell calls against the long stock.

High IV/HV Ratio

We offer the Top 5 on our home page in the Rankers and Scanners section as a regular feature. The high IV/HV ratio is the first alert that something unusual is happening as the options prices have been bid up to abnormal levels. From there a little more investigation will usually provide the answer as to the likely direction. This stock ranked number four on Friday's scan with a 1.98 ratio.

Amarin Corporation plc (AMRN) 12.52. After receiving FDA approval for the limited use of Vascepa for treatment of hypertriglycerdemia, the stock increased from 11 to 15. Now they are seeking approval to use Vascepa for lower levels of triglycerides. The recent decline from 15 back to 11 was to be the result of a brokerage downgrade due to declining confidence in an immediate acquisition, however they set a 15-price target, higher than the current level. Previously we suggested a put sale in Digest Issue 32 when it was 11.93

The current Historical Volatility is 55.86 and 45.08 using the Parkinson's range method, with an Implied Volatility Index Mean of 110.51 up from 104.53 last week. The IV/HV ratio is 1.98 and 2.45 using the range method to calculate the HV. Friday's put-call ratio was bullish at .42, while the volume was 9,864 contracts traded compared to the 5-day average volume of 27,990.

Based primarily upon the high IV/HV ratio here is another put sale to consider.

 

AMRN October put sale idea

 

Use a close below 11 as the SU (stop/unwind) or be prepared to take the stock by assignment in the event it closes below 12 at the October expiration. 

The October suggestions above use the closing middle price between the Friday bid/ask price, but have been adjusted to reflect the estimated time decay over the weekend. Monday, the option prices will still be somewhat different due to any price change. The February options are unadjusted for weekend time decay.

 

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Summary

The near term uptrend remains intact, but some selling can be expected at the September 14 resistance high at 1474.5. In the absence of any negative news from Europe, the markets will be focusing attention on 3Q earnings reports.

 

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 return with an update of our market indicators.

 

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

Comments:

Hi Jack,
Do you make a comment about a previous suggestion?
NFLX is what prompted the question. I know you said "use a close below 60 to exit" but I am just wondering in general.
Thanks

Posted by Phil on October 09, 2012 at 10:26 PM EDT

Phil,

Thanks for the NFLX question, sorry for the delay in answering. On the Monday price rise October 8, we changed the call spread strike prices to October 75/80 from October 67.50/72.50 in order to obtain a better risk reward ratio. We also note the IV advantage we originally planned mostly evaporated on Monday. Now with the pullback it is not likely to work before expiring. To answer your question, the 60 SU (stop/unwind) was set where there seemed to be good support.

Jack

Posted by Jacktrader (72.193.176.155) on October 16, 2012 at 01:31 PM EDT


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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.

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