« February 2013 »

IVolatility Trading Digest™

Volume 13, Issue 8
Downhill Momentum

Downhill Momentum - IVolatility Trading Digest

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Downhill MomentumLast week in Digest Issue 7, we noted the combination of waning momentum and the upcoming sequestration chatter was increasing the probability that the overdue market correction was about to begin. Now the increasing volume on the two down days confirms the short-term momentum is downward.

After a brief strategy comment, we offer some new ideas, the first are two alternative put spreads for USO while the third is another interesting earnings idea from our friends at KeenOnTheMarket.




In Digest Issue 7, we reported the VIX futures premium had increased and were approaching the important 20% level. By the end of last week, the day weighted had declined to 6.58% and the volume weighted was 6.89% as the futures advanced upward toward the cash on increasing volume. Russell Rhoades at the CBOE sent a tweet Thursday saying the VIX futures volume was over 196K contracts on the decline, the third highest on record with the highest being 221K contracts traded on January 2 when the S&P 500 Index advanced 36.23 points.

The combination of advancing VIX premium along with declining volume, the SKEW index above 130 along with deteriorating market breadth were enough for us to suggest a correction hedge in Digest Issue 7 that we booked last Wednesday.

Since the short-term trend is down, Friday's advance looked like an opportunity to buy some puts or open some put spreads. We think this down leg will take the S&P 500 Index (SPX) 1515.60 back to 1480 or even back to the breakout around 1460 if the sequestration babble gets unusually rancorous. So far, the media reports no resolution, no solution and no sense of urgency to address the issue.


IVOLopps™ Trend Change

United States Oil (USO) 33.60.

There are several reasons for choosing USO for our downside suggestion including the fairly high 10 day correlation of 78% with S&P 500 Index along with the recent seasonal pattern that has seen crude oil decline from February - early March highs to June lows the last two years. Checking the long-term record, crude oil usually advances in the spring, but that was not the case in 2011 or 2012 and we think the odds favor another decline this spring since there is more available crude oil than refinery capacity. In its latest release, based on February 15, 2013 data, the U.S. Energy Information Administration (EIA) reports, "U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 4.1 million barrels from the previous week. At 376.4 million barrels, U.S. crude oil inventories are well above the upper limit of the average range for this time of year."

Here is the USO chart.



After advancing along with equities from the December 11 low at 31.49 it made a well-defined multi-point upward sloping trendline, shown above as USTL reaching a high of 35.53 on January 30. It then made several closes below the trendline before retesting the high on February 13 reaching 35.49 before rolling over to close below the 34.50 support level after the EIA report on Wednesday February 20 setting off a classic double top reversal pattern. We think the downside measuring objective is much below the one determined by the double top and have set it at the November 17 low of 31where it may find support, see MO above.

In addition to its correlation with equities and the fundamental oversupply, there are two other reasons for using USO relating to edge.

Since USO uses front month futures contracts continuously rolled out at higher prices when the term structure is in contango, as now, it means there is a rollover loss, currently about 1%.

Second, due to the options market skew out-of-the money puts are more expensive as defined by implied volatility than at-the-money puts. When using vertical put spreads the options sold are more expensive, but with less gamma than the long ATM puts meaning the combination produces very favorable risk to reward ratios as shown by the March and April trade ideas below.

First the options data.

The current Historical Volatility is 15.36 and 12.76 using the Parkinson's range method, with an Implied Volatility Index Mean of 22.17, up from 19.42 last week. The IV/HV ratio is 1.44 and 1.74 using the range method to calculate the HV. Friday's put-call ratio at .50 was bullish while the volume was 98,473 contracts traded compared to the 5-day average volume of 115, 750.

Consider these alternatives



The debit cost at .55 is 22% of the distance between the strike prices means the risk to reward ratio is a very favorable 3.5 to 1, but there is only 19 days to expiration. The delta is a negative .3386 with .1401 gamma or rate of change of delta. The time decay or theta is -.0071 with vega, or sensitivity to changing implied volatility of .0172.



The April alternative has a debit cost of .71 with the distance between the strike prices of 2.5 for a risk to reward ratio of 2.5 to 1 and 54 days to expiration allowing some time for a counter trend rally in the event the downward momentum slows. Comparing the delta and gamma, both are lower than March along with less time decay and a bit less vega as well.

The price objective is the MO at 31, along with an increase in implied volatility from 22.17 to 30 based upon reversion to the mean since it has been below normal. Use a close back above 34 that would close the gap as the SU (stop/unwind).


Earnings Suggestion

Keene on the Market 2-4-13.png


Saks Inc (SKS) 11.23

Saks Inc, the New York-based luxury retail institution, operates 43 retail stores in the US and internationally, with locations in the United Arab Emirates and Saudi Arabia. Their Q4 2012 earnings conference call is scheduled for next Tuesday, February 26 at 9:30 a.m. ET with analysts estimating.15 per share on revenue of 963.14 million. While the EPS estimate is down from .17 last year, the total revenue is up from the year-earlier 925.1 million.

Last year Sacks posted impressive 56% earnings growth and further 13% growth is expected over the next 2 years.

While many are calling for a correction, so long as the bull trend continues SKS will benefit as their affluent customer base begins to shop with confidence once again. The retailer is also expanding its online business by offering shoppers incentives, including free shipping and returns for orders over one hundred fifty dollars.

The stock is bullish technically, having closed Friday at 11.20 above all the moving averages.

The suggestion is to buy SKS Aug 2013 12 Calls for .75. The current implied volatility is 35.80.



The risk is .75 with potentially unlimited reward.

All of the 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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Currently the market momentum is downward and with increasing sequester noise, it is likely to continue lower for the next week or more, but since this is likely just a correction in a longer-term uptrend be careful with counter trend trades.


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In next week's issue, we will dig into all of our important indicators to see what they have to say about the sequester babble.


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".