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Today


IVolatility Trading Digest™


Volume 13, Issue 4
Newton's First Law of Motion

Low Volume Profit Taking - 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).

 

Newton's First Law of MotionWhile Newton originally expressed it somewhat differently in 1687, the popular interpretation is that "An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force."

As it relates to the current equity market, our job is to anticipate what potential unbalancing forces could change the direction. Some analysts say a correction is due just because the S&P 500 Index (SPX) 1502.96 has advanced above the previous resistance now closing above 1500. While a correction to test the previous 1474.51 high is highly likely the timing and extent of the correction is unknown and will depend upon some unbalancing force, perhaps the Friday employment report.

We offer some further thoughts about the current uptrend below followed by additional information about the companies in Friday's Top 5 ranker results, a new addition to our Volatility Kings list and then a new iShares Russell 2000 Index (IWM) 89.94 trade idea from Options Mentor Dan Sheridan, as a contributing author.

 

Strategy

Strategy

Last week we reported the professional hedging community was growing more cautious based upon a slight increase in the VIX futures premium. This week we see the opposite as the day weighted VIX futures premium between the first and second months declined from 19.54% to 12.54% while the volume weighted premium declined from 22.51% to 12.86%.

The VIX put-call ratio increased from .38 to .46 and the SPX equity only put-call ratio increased from was .54 to .64 making the spread between the SPX equity only put-call ratio and the VIX put-call ratio .18 compared to .16 the previous week for slight increase of .02. A wider spread is market bearish while a narrower spread is bullish since means the VIX put-call ratio relative to the SPX put-call ratio is lower. As the SPX put-call ratio increases it becomes more bearish while the VIX put-call ratio is more bearish (for the SPX) as the put-call ratio declines making the spread between them wider. However, comparing to the previous Friday, the VIX futures volume declined by 39,819 contracts and the open interest declined by 7,518 contracts. The combination of a lower VIX premium and declining open interest suggests moderately less professional hedging enthusiasm although one would expect to see more hedging in anticipation of a correction as the index continues advancing.

Since the iShares Dow Jones Transportation Average Index (IYT) 104.38 appears to be the most overextended of the major indexes we are expecting the retest correction to begin here when it comes.

 

Top 5

In the "Rankers and Scanner" section of our home page we feature a complimentary ranker sample at the "Top 5 stocks by implied volatility change" link. With a click, you go to an Advanced Ranker Sample of the top and bottom 5 stock in four categories. For ideas, we often look at the Top 5 stocks based on the Implied Volatility Index Mean vs. the 30-day Historical Volatility (IV Index Mean vs. 30D HV). From Friday, here are the results.

 

Stock symbol (Company name)

IV Index Mean

30D HV

IV Index / HV ratio

412.47%

86.81%

4.75

13.50%

6.36%

2.12

39.98%

19.95%

2.00

60.72%

31.45%

1.93

86.90%

47.08%

1.85

 

Number one with a ratio of 4.75 we have CLSN accompanied by its volatility chart.

 

 

 

First introduced last year in Digest Issue 48, Celsion Corporation (CLSN) at 7.72 is awaiting an FDA announcement expected in late January. With the high-implied volatility for the February options, a one standard deviation move is between 1.76 and 12.73. As could be expected from the IV, some think the stock could go to zero while others say it will be 40 on the announcement. We should know the results soon.

PowerShares DBA Agriculture Fund (DBA) 27.58 is in second place. Since indexes and ETF's are less volatile than individual equities as indicated by a 30-day historical volatility of 6.36%, and even a bit less using the range method at 6.17%, the implied volatility looks interesting. Since it is in a well-defined downtrend an out-of-the-money call credit spread is one idea, but the options volume is low so liquidity will be an issue.

LinkedIn Corp. (LNKD) 123.78. Currently in a well-defined uptrend with a decent options volume, this appears to be an earnings story since they are reporting 4Q Thursday January 31 with a consensus estimate of .19 per shares and whisper of .22 per share. Watch for a decline in implied volatility on the earnings report.

Constellation Brands Inc. (STZ) 38.50. After breaking out to the upside of the recent range on an upgrade after the last earning report of .63 per share along with raising guidance this wine and beverage company is trending higher. A short put or a long call spread with a short put are two ideas to consider.

Green Mountain Coffee Inc. (GMCR) 46.31. Scheduled to report 1Q earnings on February 6, Green Mountain is one of our Volatility Kings and we are expecting to see higher implied volatility before the reporting date. They recently raised guidance and reports that Starbuck's competitive Verismo coffee maker sales results have been "clearly underwhelming" to date are helping boost the stock as it closed above 45. Since they have already raised guidance, an earnings surprise seems unlikely so a volatility calendar spread, short the near term option, long the deferred is one possibility.

Volatility Kings

Although the options trading volume is lower than others, we are adding SunPower Corporation (SPWR) 7.99 to our list since they are scheduled to report earnings on February 7 with a consensus estimate of .04 per share. At the last report the implied volatility reached 78 and we estimate it will reach 85 from 71.64 currently.

 

Calendar Spread

iShares Russell 2000 Index (IWM) 89.94.

Although the timing is unknown, Dan Sheridan at Sheridan Options Mentoring is also in the correction camp. Here are his instructive thoughts and ideas for IWM.

Calendars and the confusing Implied Volatility of a spread concept

Proposed IWM trade: Buy 1 March 90 put at 2.13 and sell 1 February 90 put for 1.31, net debit .82.

It seems straightforward so far. Calendars seem like a good idea from an implied volatility perspective in IWM because implied volatilities are at the lowest levels in 5 years. Because IWM (baby RUT) is at 5-year highs, we should be backing off, but who knows when? Because of price level concerns, I would trade half my calendar size at trade initiation. Then, whichever way it moved I would add an additional calendar and turn the trade into a double calendar. For example, if I normally do 10 calendars, I would start with 5. If IWM moved up next week to around 92, I would add 5 calendars at the 92 strike. If IWM moved down next week to 88, I would add 5 more calendars. In both cases, I would be turning my original single calendar into a double calendar.

Teaching time: Implied volatility level of a spread. The implied volatility of the long option in this calendar trade is 16.30 and the short option is 15.30. If I ask you for the implied volatility of each option, that’s easy. But what if I say, what is the implied volatility level of the spread? If I buy an option with 16.30 volatility, and sell another with 15.30 volatility, what one volatility number represents the implied volatility of the spread? Tougher, isn't it? A rough and tumble way to figure it out is to take the difference in implied volatility levels of the two options, for this example 1, and add it to the implied volatility of the long option, 16.30 to get 17.30. This is a more accurate level of the implied volatility of the spread. In the current extreme low volatility environment we are in, negative skews, called Contango are normal. They exist most of the time, especially in an upward trending market. Dan, what do you mean? A negative skew exists when the option volatility of the short option in a calendar is less than the implied volatility of the long option. In our proposed trade, the negative skew is 1 point since the short option implied volatility is 1 point less than the long. I think even an implied volatility level of 17.30 for the spread is reasonable but I might put the Calendar trade in at .80 because I think the negative skew is extreme.

Conclusion: I would enter this trade at-the-money for around .80 (.02 cents cheaper than proposed price) and turn it into a double Calendar once IWM moves either up or down. The implied volatility of a spread is important to get an accurate reading on the implied volatility of a Calendar.

Have a great day! Dan Sheridan dan@sheridanmentoring.com

The suggestion above uses 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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Summary

While we all know a correction to test the previous resistance will occur, the timing along with triggering news or unbalancing forces is yet to be determined. It could occur on the upcoming employment report or the market could continue higher for some time, but for now correction predictions, are just guesswork.

 

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 update all of our important indicators and check the progress of the IWM Calendar trade idea above.

 

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:

I find your IVolatility Trading Digest Blog (weekly) interesting and educational. The Volatility Kings chart is very useful.

Would this chart be available on your website to a basic subscriber?

Thank you for sharing the research information.

Posted by 204.2.196.182 on January 27, 2013 at 05:44 PM EST

Thanks for the response, comment and question. While the volatility charts are a complimentary service on the Basic Options page available to basic subscribers, Volatility Kings is a feature of the IVolatility Trading Digest, which we are intending to update more frequently.

Jack

Posted by Jacktrader on January 28, 2013 at 08:24 PM EST


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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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