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IVolatility Trading Digest™

Volume 12, Issue 42
Earnings Correction

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Election CorrectionLast week in Digest Issue 41, we proposed the correction was due to election uncertainty, but now after poor earnings reports from three large multi-national companies in the Dow Jones Industrial average, it appears the issues are earnings uncertainty including a slowdown in Europe and currency translation. 
S&P Capital IQ says they expect companies in the S&P 500 to post their worst earnings results since the third quarter of 2009.

In this issue, after a brief strategy comment, we announce the addition of daily options & open interest to our data tables, and then update our VIX futures premium indicator. Next, we report our portfolio results for the regular October options expirations, followed by a new trade resulting from the assignment of Amarin Corporation plc (AMRN) stock. Finally, we offer a conditional PowerShares QQQ (QQQ) hedging suggestion.



StrategyS&P 500 Index (SPX) 1433.19. Referring to the chart in Digest Issue 41 last week, SPX has closed below the upward sloping trendline (USTL) that began with the June 4 low at 1266.74. In addition, last week's rally that reversed Friday created a possible triple top requiring a close below 1426.68 for activation, just below the current level. In that event, we will use the double top minimum measuring objective described in Digest Issue 41 to determine the minimum measuring objective MO of 1388, shown on the chart in Digest Issue 41.

If the decline continues, then the VIX will increase along with the implied volatility of individual stocks so consider using long straddles and strangles for the Volatility Kings listed in Digest Issue 38 and Digest Issue 40.

S&P 500 Index Implied Volatility (IVXM). At the end of last week, the Implied Volatility Index Mean increased just .03 from 14.23 to 14.26, while the CBOE Volatility Index® (VIX) increased from 16.14 to 17.06

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 88% to November and 12% to December resulting in the average premium of .64 or 3.76% shown above. Our alternative volume weighting between November and December is a 4.76% premium. Last week the day-weighted premium was 10.58%, while the volume weighted was 7.51%. Fridays' volume was 135,194 contracts with an open interest of 389,616 contracts compared to 149,114 contracts traded and 419,966 contracts open interest the Friday before. Both the volume and open interest declined and the premium levels are the lowest in many weeks.

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. The current level suggests a significant decline in hedging activity last week.




Last week we began adding both the daily volume and open interest to the data tables at our complimentary Basic Options, Advanced Options and Advanced Historical Data pages. Located to the right of the stock volume, users can now easily compare volume and open interest against the one-week averages, making it easier to identify active option activity going into an earnings report, a takeover rumor or other events. Updated in the evenings after the close they will be available before the market opens the next day. Since Advanced Options also provides intraday data, the previous day's volume and open interest continues displaying until updated after the close each day and available when clicking on the "market close" link.

Since we had an unusually large number of options position expiring on the regular October expiration last Saturday we began closing the oldest ones Wednesday and continued Thursday and on the close Friday. Since none were offsetting hedges almost all were profitable. In total there were 16, all one-lot positions, many more than we usually carry to expiration. The final tally was one 143 loss, one stock position assigned from a short put and 14 gains ranging from a low of 2 to a high of 388 with a median of 93.

The assigned stock was Amarin Corporation plc (AMRN) 11.26 resulting from a short October 12 put position suggested in Digest Issue 40. The initial credit was .75 so our basis is very close to the current price after deducting the put sale proceeds from the assignment price of 12.

Refreshing our memory we note the company received FDA approval for Vascepa, a treatment for high levels of triglycerides, but a brokerage downgraded it since it had not yet received an acquisition bid. Since the implied volatility remains high and rising, expectations remain high.

The options details follow,

The current Historical Volatility is 51.51 and 53.20 using the Parkinson's range method, with an Implied Volatility Index Mean of 119.02, up from 111.57 last week. The IV/HV ratio is 2.31 and 2.24 using the range method to calculate the HV. Friday's put-call ratio was in bearish territory at 1.00, on a sudden decline in call volume. The total volume was 8,842 contracts traded compared to the 5-day average volume of 13,970.

We notice the implied volatility is rising, last month is was 93.27, which means expectation and/or uncertainty is rising. With the favorable IV/HV ratio of 2.24 we suggest selling more options so here is a strangle adjustment suggestion.

Since we are long 100 shares of stock, we can sell an out-of-the-money call. In addition, we also want to sell an out-of-the-money put below the most recent pivot at the support from last May before the FDA approval.


Amarin Corporation plc (AMRN)


Although the implied volatility is still rising, the November options will soon be losing time value rapidly. In the event both expire worthless, our basis in the stock will be 9.42 below the May support level. The risk is assignment of another 100 shares in the event it closes below 10 at the November expiration.


Since the SPX has closed below our upward sloping trendline detailed above and shown on the Digest Issue 41 chart, it is time to consider implementing a hedge and because there seems to be a low level of concern about a further decline from our VIX futures premium indicator, we want to make it conditional.

PowerShares QQQ (QQQ) 65.68.

While the QQQ also closed below its upward sloping trendline, it has been weaker than SPX for the last few weeks. There is considerable support at 65 so we suggest using a close below 65 as the first condition.

The second condition is for the SPX to close below the August 21 support at 1426.68 mentioned above. If both conditions are satisfied early this week then consider this hedge.

First, the relevant options data,

The current Historical Volatility is 14.28 and 11.67 using the Parkinson's range method, with an Implied Volatility Index Mean of 18.25 up from 16.99 last week. The IV/HV ratio is 1.28 and 1.56 using the range method to calculate the HV. Friday's put-call ratio was bearish territory at 1.58, but within the .75 to 2.50 range since it is a hedging favorite. The volume was extremely high at 866,677 contracts traded compared to the 5-day average volume of 488,190.


PowerShares QQQ (QQQ)


At 27% of the width between the strike prices, it has a good volatility edge and risk reward ratio. In the event both conditions are satisfied use a close back above the last pivot at 68.30 as the SU (stop/unwind). If the decline continues, it should provide an effective hedge since we only have 2 November positions from previous Digest issues, one a straddle and the other a put spread.

Both suggestions above use the closing middle price between the Friday bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.


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This week may begin much like last week after the second sharp decline in as many weeks. However, since the market is squarely focused upon earnings, more disappoints will mean a further down leg, but since the VIX premium indicator is not suggesting great concern it could just as easily rebound just like last week.


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In next week's issue, we will update all of our indicators and review this week's hedge suggestion.


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.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".