« September 2007 »

IVolatility Trading Digest™

Volume 7, Issue 32
Ben Delivered

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).

On September 18, 2007 Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve and the Federal Open Market Committee delivered the goods - a cut in Fed Funds rate. They surprised the financial markets by delivering a more than expected 50 basis points reduction. Now we wait to see how the markets will react. The initial indications from equities were positive but the 30-Year Treasury bond declined along with the dollar. Are the long bonds and the dollar signaling the start of a trend toward higher long-term interest rates and a continuing dollar decline? It is to soon to tell but it must be considered a possibility. If so, this would give further support to commodity prices, energy prices, and international equities.

Market Review

Market Implied Volatilities for both the S&P 500 and the NASDAQ 100 immediately dropped below their upward sloping trend lines in a clear reversal of trend. For the S&P 500 the calls IV Index declined from 22.67 the prior week to 15.80. The S&P 500 puts declined from 22.72 to 17.34. For the NDX the IV Index for the calls declined from 23.90 to 16.97 and the puts from 23.83 to 18.86. For both indexes the puts have not, as yet declined as much as the calls.

The US Dollar Index (DX) 78.60, basis cash, is now approaching the 1992 all time low of 78.33. For the near term the most likely path is lower. PowerShares DB US Dollar Index Bearish Fund (UDN) 27.20 can be used as US dollar hedge as it rises with the dollar decline.

With the equity market rally on the Fed action last Tuesday the NYSE Advance/Decline ratio scored an impressive 8.7 times more advancers over decliners. For the remainder of the week the ratio was less impressive. Nevertheless, the final tally for the week showed 1.3 times more issues advancing then declining. The McClellan Summation Index improved 186.34 points, now reading a still negative –60.63, but with a well-defined uptrend underway improving the equity outlook.


The strategy remains about the same as we suggested last week. From a portfolio perspective review positions to see that we have both long and shorts. China, Oil and Oil Service, Ocean Shipping, Infrastructure, Agriculture, Agriculture Machinery, Industrial Machinery and selected Casinos stocks with Macau operations are among the long suggestions. On the short side the Homebuilders, Mortgage companies and selected retail are the areas to consider. Further, with the lower dollar we can expect Canadian, Australian and European buyers to be active acquirers of US companies.

With the continued dollar decline we did see gold moving higher. The Market Vectors Gold Miners ETF (GDX) 45.48, rose 7.8% from 42.17 last week along with a 2.4% rise the previous week. From a chart perspective it has broken out above the July high of 43.30. We will be watching this sector closely to see if the rally continues. The Federal Reserve has few good choices available to support the dollar, but the central banks could renew gold sale programs.

Takeover Rumors

Cree Inc. (CREE) 32.15. This company develops and manufactures semiconductor materials and devices primarily based on silicon carbide, gallium nitride, and related compounds. The company produces light emitting diodes (LEDs), and high-power products. The LEDs are used in various applications, including backlighting for mobile products, automotive interior lighting, electronic displays, gaming equipment, consumer products, and other electronic equipment. Rumors have General Electric (GE) or somebody else as the buyer. General Electric reportedly denied any interest in buying the company.

This is what the volatility and price charts says.
Both volatility measures have been rising along with the stock price. When and if a takeover or buyout is announced they can be expected to decline. If the rumors prove to be false and there is no bid made the volatility will still most likely decline but at a slower pace. The sale of a near term October 30 put would benefit from the high volatility and the stock has support at the 30 price level. Since Implied Volatility has not yet turned lower there is a chance it can still be going higher.

Trade Plan:

Put sale

DR: Takeover rumor. Risk appears reasonable.

SU: A close under 25 would be the level where we would unwind the position.

Sell CREE Oct 30 put CQRVF 1.45 IV 69.28 Delta .3192

Noble Corp. (NE) 50.74. Noble provides contract drilling services for the oil and gas industry with a fleet of 63 offshore drilling rigs, 13 semisubmersibles, 3 drillships, 44 jackups, and 3 submersibles. The rumors have SeaDrill from Norway working on a three-way deal with Noble and two other offshore drilling companies. Last Thursday Noble’s Chairman and CEO resigned giving a good indication that something is developing.
The volatility measures are both high and are likely to be declining. Even when rumored deals come true they often take much longer to develop and be announced than the options market expects. The near term October 47 ½ put could be used in combination with a longer-term bull call spread. Do some research on the offshore drilling sector and then consider this suggestion.

Trade Plan:

Combination of put sale and bull call spread.

DR: Takeover and consolidation in the offshore drilling sector. If the takeover does not occur business conditions are still good and the company will continue operating.

SU: A close below 45 would change the outlook for this position and would require unwinding.

Sell NE Oct 47 ½ put NEVW .90 IV 39.92 Delta .2499

Buy NE Dec 50 call NELJ 4.60 IV 38.79 Delta .5934
Sell NE Dec 55 call NELK 2.425 IV 37.70 Delta -.3950
Spread debit 2.175 Position net delta .1984

Mining Companies

The combination of the equity market recovery and the cut in the Federal Funds rate produced a double bonus for the mining companies. Many have already broken out above their previous July highs.

Teck Cominco Ltd. (TCK) 48.02. Vancouver based Teck Cominco produces zinc, copper, and metallurgical coal, as well as precious metals, lead, molybdenum, electrical power, fertilizers, and various specialty metals. It also owns an interest in oil sands leases, and has a partnership interest in an oil sands development project. It is rapidly approaching, but has not yet exceeded its July 13, 2207 high of 50.89.

With a Historical Volatility of 43.86 consider this bull call spread:

Buy TCK Feb 50 call TCKBJ 3.80 IV 36.53 Delta .4983
Sell TCK Feb 55 call TCKBK 2.050 IV 35.24 Delta -.3288
Debit 1.75 Position net delta .1695

Freeport-McMoRan Copper & Gold Inc. (FCX) 108.67. Freeport-McMoRan, engages in the exploration, mining, and production of copper, gold, and silver. It holds interests in the Grasberg open pit and the Deep Ore Zone mines in Indonesia. The company also owns interests in the Grasberg block cave, Kucing Liar, Deep Mill Level Zone, Ertsberg Stockwork Zone, Mill Level Zone, Big Gossan, Dom open pit, and Dom block cave. In addition, it smelts and refines copper concentrates, and markets refined copper products.

With a Historical Volatility at 54.51 and likely to decline consider this put sale:

Sell FCX Oct 95 put FCXVS 1.425 IV 52.03 Delta .1592

Companhia Vale do Rio Doce (RIO) 30.45. Rio de Janeiro based RIO operates as a diversified metals and mining company worldwide. It produces and exports iron ores and pellets to the steel industry, as well as manganese ores, iron alloys, and metallurgical ore. They also produce nickel, copper, platinum-group metals, such as platinum, palladium, rhodium, ruthenium, and iridium; precious metals, including gold and silver; coal; and other non-ferrous minerals. In addition, their operations include bauxite mining, alumina refining, and aluminum metal smelting operations.

With a Historical Volatility on the high side at 65.28 and expected to decline consider this put sale:

Sell RIO Oct 27 ½ put .60 IV 51.21 Delta .2217

Barrick Gold Corp. (ABX) 40.06. Toronto based ABX products include gold, copper, silver, and zinc. The company holds interests in various gold mineral resources in the US, Australia and South America.

With a Historical Volatility of 47.19 consider this bull call spread with 7 ½ points between the strike prices and a good 4.5 risk to reward ratio.

Buy ABX Jan 42 ½ call ABXAV 2.40 IV 34.83 Delta . 4482
Sell ABX Jan 50 call ABXAJ .75 IV 36.06 Delta -.1830
Debit 1.65 Position net delta .2652

Reader Response Request

Once again we encourage you to let us know what you think about how we are doing and what you would like to see in futures issues. We welcome your suggestions. If you have questions or comments just let us know. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.

Gentlemen/Ladies--- I like your trading digest very much.Please continue this service. Thank you.----P. Whaley Baynard----email----wbaynard1-AT-comcast-DOT-net

Posted by P. Whaley Baynard on September 23, 2007 at 11:40 PM EDT

I look forward to the Digest on Sunday evening. I'm an amateur at this and I must use my resources carefully. I cannot sell bare puts or calls but it would help my confidence level when you call out a put sell if there were a corresponding spread. I have found some that work but I need the backup of more experienced traders. Also I was a little surprised that the SLM calendar spread didn't show up in the digest.

Posted by Al Killinger on September 24, 2007 at 08:22 AM EDT

What happened to your time spread recommended months ago, on MIR? I have a big loss? edfrank

Posted by Edward Frank on September 24, 2007 at 10:45 AM EDT

I would like to see some Credit Spreads.

Posted by r.c.wilson on September 24, 2007 at 10:50 AM EDT

what are we looking to see happen with
the SLM calendar spread, when would one
unwind this spread?

Posted by renda layton on September 24, 2007 at 12:16 PM EDT
Website: http://rendalayton@comcast.net

P. Whaley,

Thank you for taking the time to send us your comment. Your support is greatly appreciated.


Posted by Jacktrader ( on September 24, 2007 at 12:32 PM EDT


Thanks for the comment. Often the reason for put sale suggestion is a function of the near term IV being higher than the later months. This would also fit the calendar spread criteria, except for calendar spreads we don’t want large stock price moves. In the case of the put sale we do want large upward stock moves. Recently our Calendar Spread Ranker that is shown on the Home Page selected SLM. Make sure to do the fundamental work and understand the risk and the potential of a large move in the underlying whenever you consider Calendar Spreads.


Posted by Jacktrader ( on September 24, 2007 at 01:46 PM EDT


Thanks for the question on MIR. Actually we suggested MIR in two issues of IVTD, 15 and 18. The first was a Sep/Jun spread, both of which have now expired. The second suggestion in IVTD 18 was for a long Dec 45 call and short Jul 50 call with a debit of 3.875. The trade plan also suggested unwinding the spread with a close under 40 and it closed at 39.59 on July 24th. The short call would have expired so we would have sold the long call for the loss. From your question I assume you did not follow the suggested trade plan and this is now the long call you are concerned about. Your total risk is the debit of 3.875. You can’t lose more than this amount. In a financial environment that has materially changed with respect to the financing of buyouts having this defined downside risk is a real advantage. I am assuming that since the Jul 50 call expired you are still long the Dec 45 call. Currently the Dec 45 call is worth 1.325, so you could sell it and close your position with a total loss of 2.55. This would not be such a bad out come in light of the changed circumstances. However, looking at the price chart, the stock it appears to be in an uptrend off the August 16th low. Since you are long the Dec 45 call it is now gaining value as the price goes higher. The current delta is .3407, which means that a dollar increase in the stock price will increase the value of your call 34 more cents. There is a chance you could be about even at expiration of the Dec 45 call. Since I would not expect the stock to continue rising without a pull back I would be looking to sell another call creating a new spread when it does. For example, if this uptrend was broken today the Oct 42.5 call would be a good sale candidate. This would reduce your cost by another .925. I would not do it until there is an indication that the stock is turning lower, by breaking the upward sloping trend line, or by using and indicator such as relative strength or stochastic. You still have two more expiration months that can be sold to create a new spread, reducing you cost.

The reality is that market circumstances change. Using spreads gives you a defined risk. The other reality is they do not all work as originally planned and the subsequent management of the trade is as important as the initial trade.


Posted by Jacktrader ( on September 24, 2007 at 03:14 PM EDT


Thanks for the credit spread request. I will put it on my list and see what I can find.


Posted by Jacktrader ( on September 24, 2007 at 03:46 PM EDT


Thanks for the question. This spread was not one that was included in the Digest, it was from our Ranker on the Home Page. I did not record the details, but if you will give them to me I will be happy to take a look and offer suggestions.


Posted by Jacktrader ( on September 24, 2007 at 03:58 PM EDT

Dear Jacktrader,
Thanks for responding to my question.
The SLM bull spread I am referring to is the
one that was on the home page/ranker on
Aug 31 ie: BTO slmaj jan0850
STO slmjj oct50
what are looking to see happen to unwind
this spread? Thank you, Renda Layton

Posted by renda layton on September 26, 2007 at 12:20 PM EDT
Website: http://rendalayton@comcast.net

hey::: how's about them 37.50's on FMCN bidding 0.05. I'm trying to close mine out for my Sept. acct making it the best this year. Book a flight to Vegas. Have a good Al B

Posted by Al Boling on September 26, 2007 at 01:08 PM EDT

what effect does the HV and IV have on options?please explain.CKS

Posted by ken shaffer on September 26, 2007 at 04:34 PM EDT


Thanks for responding back on the SLM Calendar spread. We have advised on several occasions in the Digest about Calendar Spread suitability when a large move in the underlying stock is possible. It is imperative to do the fundamental homework on the stocks before making any trade. You need to understand the risk you assume. Sallie Mae (SLM) is the subject to a private equity bid at $60 that is now in trouble due to changed market circumstances for the financing to buy the company. It may become end in a lawsuit. Get today’s newswire reports and read about the developments. At this point it is still uncertain so the implied volatility is likely to remain fairly high. Since we are not takeover risk arbitrageurs I would suggest you consider closing the position.


Posted by Jacktrader ( on September 26, 2007 at 10:48 PM EDT


Thanks for the news. The implied volatility numbers made it a very tempting target. Glad to hear you it worked out.


Posted by Jacktrader ( on September 26, 2007 at 10:56 PM EDT


Thanks for your question. Volatility as defined as Historical Volatility and Implied Volatility is the basic starting point to understanding options. There is too much to explain in a blog. Suggest you start with the Options Industry Council: www.888Ooptions.com. Then get the book Option Volatility & Pricing by Sheldon Natenberg.


Posted by Jacktrader ( on September 26, 2007 at 11:56 PM EDT

Dear Jacktrader,
I don't mean to overkill the subject but I'm confused about this SLM spread. Given
Sallie Mae is the subject of a takeover bid
and this has been in the works. Why would it be considered a "best calendar spread" on Aug 31 and again on Sept 24?? Renda

Posted by renda layton on September 27, 2007 at 02:30 AM EDT
Website: http://rendalayton@comcast.net


You have a good question. The Ranker selects option suggestions based upon a determined selected criterion. In this case the criteria was set for Calendar Spreads and is based upon the difference in the Implied Volatility of the near term options compared to the Implied Volatility of the deferred month options. The Ranker does not know why the Implied Volatilites are different. We are offering suggestions based upon options ranking criteria. It is the job of the user to determine why the volatility numbers differ and the level of risk the user is willing to assume. You must do the fundamental research and risk analysis work.


Posted by Jacktrader ( on September 27, 2007 at 10:35 PM EDT

Permalink Comments [18]

Comments are closed for this entry.

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".