« September 2008 »

IVolatility Trading Digest™

Volume 8, Issue 33
Financial Crisis

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).

In popular Western culture we are told that the word “crisis” in Chinese is composed of two characters, the first is the symbol for danger and the second is for opportunity. However, in Mandarin the word for "crisis" is wēijī consisting of two syllables that are written with two separate characters, wēi and jī. While wēijī does mean "crisis" and the wēi syllable in wēijī does indicate "danger," the jī syllable in wēijī does not signify "opportunity." The jī in wēijī, means a crucial point when something changes.  Thus, wēijī is a time when things start to go awry. A wēijī indicates a perilous situation when one should be especially wary. Perhaps caution is a better translation.

While the financial markets are said to be in crisis we are beginning to see stability in the financial ETF as some of the banks and brokers have been rising in price for this past week. Keeping in mind we should continue to be especially wary we are going to suggest a financial "opportunity" from an options perspective.

First a quick review of the equity market and another suggestion for the improving US dollar. Then we have a delta neutral volatility idea followed by two more interesting suggestions based upon unusual call volume activity.

Market Review

S&P 500 Index (SPX) 1282.83. In the past three weeks the SPX has made three unsuccessful attempts to cross above 1300. Since we are still looking for a retest the 1200 low we think it is unlikely it can clear the 1300 level without out first retesting 1200.

CBOE Volatility Index (VIX) 20.65. The VIX continues to display a slight downward bias and as yet provides no indication that the SPX is ready to test the lows once again. If you watch the market daily and can close a position intra-day, this may be the time to be looking for a long bull call spread on the VIX.

US Dollar Index (DX) 77.38. Now trading above 77 with the next resistance at the December 20, 2007 high at 77.85. We were expecting some corrective action perhaps back down to 75 before resuming this new uptrend, but now we are not so sure as it appears to be making a yet undefined continuation pattern between 76 and 77.

NYSE McClellan Summation Index. Our market breadth indicator continues to support the higher market thesis. After pausing the week before last it has resumed its ascent. The current reading is now -275.01 after gaining 130.44 last week.

Short Euro Long Dollar

As an alternative to the PowerShares DB US Dollar Index Bullish (UUP) 23.94 we suggest looking at the CurrencyShares Euro Trust (FXE) 147.20 using a bear put spread. The FXE options currently trade about 7 times the volume with 18 times the open interest compared to the UUP. This added liquidity means it is easier to get the spread trades completed with less slippage between the bid and offer prices and hopefully this will translate into a lower net debit for the position. Since these two ETFs appear to be mirror and inverse images the added liquidity should help minimize transaction costs without diminishing the direction effect.

With a current Historical Volatility of 9.70 consider this alternative strategy for the higher dollar.


Financial Opportunity

Direct from the "Options Data Analysis" and the "Rankers & Scanners" sections of our front page we offer this "Best Calendar Spread" suggestion for your consideration.

Lehman Brothers Holdings Inc. (LEH) 16.09. With unusually high call volume it appears LEH is attempting to turn higher on substantial stock volume. While we are not suggesting the fundamental financial sector problems have been resolved in general or LEH in particular we do see an options opportunity. It is now trading above the downward sloping trend line defined by the May 2, 2008 high at 49.88 that touches the August 6 and August 22 highs of 20.90 and 15.93 respectively. If LEH is to make a bottom this is the first step. The next and more important downward sloping trend line from the February 4, 2008 high of 66.55 and the May 2, 2008 high at 49.88 is now up at 27 ½ and this could be the trading objective for this move.

Here are the details of the Best Calendar Spread. The current Historical Volatility is 124 and now declining.

The objective is to capture the high Implied Volatility price of the near term option while hedging the position with an option that has the same strike price with a later expiration but is less expensive as measured by the Implied Volatility. We are buying IV 98 and selling IV 113. We will have some management issues if the stock in above 16 on the October expiration as we are expecting. Then since we will still be long the Jan 16 call we should have the opportunity to repeat the process several times as LEH moves higher.

Here is an alternative suggestion for the high Implied Volatility.

The Implied Volatility of this put is considerable higher at 145.77 but we run the assignment risk if the first downward trend line is violated as the stock comes back down again. In this case we should be prepared to take the stock and then sell expensive calls. Size the position with the potential assignment incorporated into the plan.

Rising Volatility Delta Neutral Trade

Eli Lilly & Co. (LLY) 46.65. The rising options Implied Volatility of LLY was enough to place it number 4 in our TOP 5 list based on "IV Index Mean vs 30D HV" with a ratio of 1.71. It started rising on the recent negative news about their diabetes drug they share with Amylin Pharmaceuticals (AMLN). When checking our volatility chart at Advanced Historical Data we note that the Implied Volatility also started rising in the first week of September last year and continued higher until they reported earnings in mid October last year. We think the recent negative news may have hastened the seasonal rise in Implied Volatility that would have started next week and think there is a good chance this could be a similar opportunity. Since LLY is not trending and has a high call/put volume ratio of 2.34 this is an opportunity for a long straddle going into the next earnings report scheduled for October 23, 2008.

DR: Delta neutral volatility trade going into the earnings report. We expect Implied Volatility to continue rising to the 40 level.

Adjust: Weekly based upon a one standard deviation move or 1 point.

SU: Unwind the position if the Implied Volatility does not continue rising in the next two or three weeks.

With a current Historical Volatility of 17.11 and an Implied Volatility Index Mean of 29.34 consider this plan.

Net credit 991.15 (455 for the options less 1,446.15 for the stock sale). Initial position net delta .0048

High Call Volume

(AFL) AFLAC Inc. (AFL) 56.70. The recent high call volume has led to speculation that there is more than just the recently announced 825 million-dollar stock buyback going on at this insurance company that is represented by a duck in its advertising. The End of Day call/put volume on Friday was 17 and since they reported second quarter earnings on July 23, 2008 there could be something else causing a large number of call purchases. With a current Historical Volatility of 30.47 consider this idea.

This November spread with a defined risk and a good reward to risk ratio should allow enough time to reveal the driving force behind the unusual call buying volume.

Clean Energy Fuels Corp. (CLNE) 17.24. Seal Beach, California based CLNE provides natural gas as an alternative fuel for vehicle fleets. It designs, builds, finances, and operates fueling stations and supplies compressed natural gas and liquefied natural gas. T. Boone Pickens owns 47% of the company and the Wall Street Journal recently reported the US House of Representatives Speaker Nancy Pelosi and her husband, who live in California, have invested between $50,000 and $100,000 in the company. This is important since California has Proposition 10 on the November ballot that is attempting to use $5 billion of California government funds to promote alternative fuel vehicles and renewable energy. Analysts say the voter's authorization of Proposition 10 could have a significant impact on the number of natural gas vehicles in the US. The recent stock trading volume is 4 times normal, as it broke out about above 15.50. Chances are it will now pull back as the news fades from memory. If you think any pull back will be temporary and not meaningful then here are two suggestions. On the other hand, if you think the stock will return to 15 or below then you may want to add it to your alert list and wait for the pull back to be completed.

With a current Historical Volatility of 57 and a Friday End of Day call/put ratio of 11.23 consider these ideas.

In the event of a pullback be prepared to take in the stock by assignment and then sell calls against the long stock position. In this case the basis would be 14.275, the level before the recent news was released causing the volume and price surge.

Here is the alternative longer-term bull call spread.

This position has a defined maximum value of the difference between the strike prices or 2.5. With a cost of .525 it has a good reward/risk ratio of 4.8. Some other risks to consider include the lack of current profitability and the results of the November ballot proposition.

Incidentally, a combination of both positions would result in a net credit of .20

Previous Issues and 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. 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 for us to take a look at a specific stock or ETF just let us know. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.


Hello, Is there anyway to track certain stocks that show historical tendencies of repeating themselves over and over again? There is a program that charges several thousand dollars for this information and I wanted to see if that could be done a little less expensive than that, using a volitility chart for a particular stock to achieve the same thing?

Also, where could I learn more about using volitility in relations to a stock price in choosing whether an option is reasonable for purchase. thanks, Eddie

Posted by Eddie Herrin on September 02, 2008 at 11:24 AM EDT

For Delta Neutral Trade (LLY), why we have to sell 31 shares of stock to get delta neutral.
Thank you

Posted by Sugianto Yap on September 04, 2008 at 05:51 AM EDT

I still don't understand

Posted by on September 04, 2008 at 05:54 AM EDT


Thanks for the question about reoccurring patterns. We assume you are referring to reoccurring volatility patterns. First we want to apologize for the delay in responding. It seems our response notification system had some problems.

There are a good number of issues that show reoccurring volatility patterns, usually in the run up to the quarterly earnings report. We do use our IVolatility.com volatility charts for this purpose.

As for references, I suggest exploring the many articles we have on our web site at the Knowledge Base, Education and Webinars pages.

One of the books that we continue to recommend that does a good job explaining options volatility and strategies is Options Volatility & Pricing by Sheldon Natenberg. Probus Publishing Company, Chicago.1994.


Posted by Jacktrader ( on September 08, 2008 at 08:32 PM EDT


Thanks for the question on the delta neutral LLY suggestion. First we want to apologize for the delay in responding. It seems our response notification system had some problems.

If a straddle is going to be delta neutral we need to adjust the deltas of the two legs of the position so they are as close to being neutral or zero as possible. This can be done by a combination of options or by using either a long or short stock position to make the overall straddle neutral. In this example, we suggested using the stock. When we set up the trade the long Oct 45 call had a delta of .6755 and the long Oct 45 put delta was
. -3266. Combining the two would give us a position that was long .3489 delta. Therefore in order to get to neutral we would then need to sell 35 shares of stock.

To better see the numbers remember each option is for 100 shares of stock so the long call position is actually .6755 times 100 or 67.55 and the long put is actually -.3266 or –32.66. So now we combine 67.55 and –32.66 and we get 34.89. In order to get to the desired value of zero we then sell 35 shares of stock, each with a negative delta value of one. The result is -.11 and close to zero.

With the straddle delta neutral we have a volatility trade, but we will have to adjust it occasionally in order to maintain the neutrality.


Posted by Jacktrader ( on September 08, 2008 at 08:59 PM EDT

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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".