« November 2008 »

IVolatility Trading Digest™

Volume 8, Issue 43
Change is Coming

The one clear message from the US election is that change is on the way. Change is coming to America. Since the new administration will not take office until January and since the financial markets don't like uncertainty we can expect to see the volatility continue. There is likely to be considerable speculation about many things for the next two months, but no more so than the future structure and regulation of the financial markets.

"Every Man with a new idea is a crank until the idea succeeds." – Mark Twain,
(Pen name of Samuel Longhorn Clemens, American novelist and satirist 1835-1910)

In this issue we offer some added suggestions for using volatility to enhance portfolio performance while hedging risk. We have compiled a list of stocks to consider either for covered call writing or put selling. Then we will update the running crude oil short and two stocks in the takeover file. First a brief market review.

Market Review

S&P 500 Index (SPX) 930.99. Despite three days of moves in excess of 4%, at the end of the week the SPX was 37.76 points lower for a net decline of 3.9%. We continue to use 1100 as the upside measuring objective from the small double bottom between the lows of 839.80 and 845.27.

CBOE Volatility Index (VIX) 56.10. Even though the SPX declined more than 5% for two consecutive days the VIX closed 3.79 lower for the week. For now the VIX appears to have less enthusiasm for another large spike to the upside.

US Dollar Index (DX) 85.91. The US Dollar increased .28 for the week and is now in the process of making what appears to be a classical continuation consolidation pattern. If so, the breakout would be at 88 with an upside measuring objective at 93 adding downward pressure on oil and commodity prices.

TED Spread 2.01. The TED spread shown at Bloomberg is now 2.01. While we calculated the difference between 13- week Treasury Bills and 90-day LIBOR at 1.56 what's undeniable is the spread is declining and appears no longer to be a major market concern.

NYSE McClellan Summation Index. Our market breadth indicator continued higher last week with an additional gain of 307.43 points, now at -1.134.26. Even with two large down days for the SPX the Summation Index continued higher which is encouraging from the bullish perspective.


The uncertainty of change is likely to keep options implied volatility higher than what would be considered normal for the next two months. This should provide many more opportunities for selling option combinations. We think the focus should be on stocks with little exposure to the consumer discretionary sector, with good dividend yields and manageable debt levels. At year-end numerous companies will take the opportunity to write off more than the usual number of questionable items, consequently be aware that earnings estimates are going to be reduced and in some cases even dividends will be in jeopardy.


There are many options opportunities available and rather than suggesting specific options we have prepared a list of stocks for consideration. The selection criterion includes dividends in excess of 3% with reasonable debt levels, except for the banks which are in a special category with government assistance. Most have good options liquidity but there are a few that are fairly thin so be sure to check the options trading volume and the bid/ask spreads before placing an order. All have the potential for declining implied volatility and have been sorted by the potential decline in the last column with light green shading. The forecasted declines will vary and are based on the concept of regression to the long term mean and they will not necessarily return to their mean during any specific option period.

Unless precluded by account restrictions, such as those found in IRA or 401K accounts, the sale of cash covered puts in a margin account could be the first step in a covered call writing strategy. If the sold put expires worthless then the high sold premium is retained and the process can be repeated in subsequent months. If the stock declines and closes below the strike price at expiration then assignment will occur providing the opportunity to sell call options on the newly assigned long stock. If you were initially willing to buy the stock and sell covered calls then you should be equally willing to start the process by selling expensive cash covered puts. Focus on November out-of-the-money puts with high implied volatility. For covered call writing more premiums can be obtained by using December or January options with 30 to 60 days before expiration. In the table below are suggestions as of Friday's close with the Current Price, Dividend Amount, Dividend Yield, Price to Earnings Ratio, Options Implied Volatility Index Mean (IV Now), Implied Volatility Forecast (IV Fcst), Implied Volatility Forecasted Decline (Fcst Dec) and sorted on the forecasted decline in implied volatility annual percent in the last column with light green shading.

* Options implied volatility forecast
* Implied Volatility annual percent forecasted decline

Short Crude Oil Update

United States Oil (USO) 50.04. This ETF reflects the spot price of West Texas Intermediate (WTI) light, sweet crude oil. Last week USO declined 5.05 while the Implied Volatility Index Mean increased 6.88 to 85.64 from 78.76. The mid price of our existing long November 60, short November 55 bear put spread increased to 3.85 from 2.85 the previous week. Our current position cost is a credit or net gain of 6.10 or $610 since the initial combination suggestion five weeks ago.

Since crude oil prices turned down once again we suggest adding another bear put spread. Consider adding this December bear put spread.

This is an additional direction trade with a maximum value limited to the difference between the strike prices or 6 points. With a USO price target of 40 the spread would reach its maximum value with a potential 3.35 gain as it approaches the December expiration.

We suggest keeping the SU (stop/unwind) set at a close above 60.

Takeover File Update

Yahoo! Inc. (YHOO) 12.20. We last made a YHOO suggestion in IVolatility Trading Digest™ Volume 8, Issue 27, Bears and Oil, dated July 21, 2008, when it was trading at 22.45. We had been making YHOO suggestions for most of the summer with mixed results.

Once again interest in YHOO is picking up now that it has lost the opportunity to do a search deal with Google. Once again there was speculation that Microsoft would make a bid to buy the company, but that idea was quashed by Steve Ballmer last Friday. Bloomberg News reported that he did say. "I'm sure there are still opportunities for some kind of partnership around search." While Microsoft remains aloof many analysts seem convinced that some sort of deal is still likely even if it takes a change in leadership at Yahoo! in order for a deal to be made.

We return once again by suggesting a bull call spread based upon the possibility that something happens before the options expiration in January. With a Historical Volatility of 84 consider this idea.

With no volatility edge this position has a maximum value of 4 points which is the difference between the strike prices. There is good liquidity in the options and the time value is slightly positive so the net debit should be about 1.90 on Monday presuming the stock price remains unchanged, which is unlikely. Use the net delta value of .2857 to adjust for the price change. For each one stock point higher the debit would be .29 more, if lower the debit would be adjusted down by .29 for each one stock point.

On a price above 12.25 the position will make money and with the announcement of a deal the implied volatility will decline which will also be of marginal help to this bull call spread.

We suggest setting a SU (stop/unwind) at a close below 10 for a maximum loss of about $66 on a one lot position.

Anheuser-Busch Companies Inc. (BUD) 65.69. From St Louis, BUD makes and distributes beer in the United States and internationally. The domestic beers are Budweiser, Michelob, Busch, and Natural brand names.

BUD is in the process of being acquired by Belgian-Brazilian InBev at 70 per share in a deal that was agreed in July. Now management is confirming that all outstanding lawsuits challenging the deal have been settled and both companies are confirming that the deal will close before year end and that the price will remain unchanged. The now rapidly declining options implied volatility seems to be confirming the new expectations with the Implied Volatility Index Mean at 42.

We last suggested selling December puts on BUD in IVolatility Trading Digest™ Volume 8, Issue 41, Brothers Grimm, dated October 27, 2008. The stock price was 56.93 and the Implied Volatilities were in the 85-95 range for the December puts.

With a rapid rise in the stock price from 55 the Historical Volatility is now 50. Here are two more BUD ideas.

Since these prices are based upon Friday's close they will be somewhat less on Monday due to time decay. The Nov 60 should be around .60 before considering any price change while the Dec 60 should be around 2.25.

Seldom do we have a chance to sell fire insurance while it is raining and this may be one of those times. Perhaps this BUD is for you.

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. If you would like to receive the Digest by e-mail let us know at Support@IVolatility.com.


How can we explain that one can get this spread for FREE
buy BUDFM @ 4.20 BUD Jun 2009 65.0000 call
sell BUDAM @ 4.20 BUD Jan 2009 65.0000 call

Posted by Jackie on November 10, 2008 at 08:55 PM EST


Thanks for the interesting question about the pricing of the BUD Jun 65/Jan 65 spread. Based upon the closing mid price the spread has an indicated debit of .55. Which is about where you would expect it to be since the takeover price is 70. Even if you can get it a something less it has doubtful value. The takeover is scheduled for sometime in December so the call will be exercised at 70, which means the sell will have to deliver stock or sell his call option and the market will not let you sell the option at fair value. This creates the problem of buying to stock on the last trading day, and it can be call at anytime. The other problem is the slight positive Vega, the sensitivity to changes in implied volatility. On the last day of trading the implied volatility will also decline taking the indicated debit of .47 of the .55. Based upon this is appears to be priced about right. If you pay zero it will be worth zero, if you pay .55 you will lose it and have the short delivery risk.


Posted by Jacktrader ( on November 11, 2008 at 12:14 AM EST

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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".