« January 2009 »
SunMonTueWedThuFriSat
    
1
2
3
4
6
7
8
9
10
11
13
14
15
16
17
18
20
21
22
23
24
25
27
28
29
30
31
       
Today


IVolatility Trading Digest™


Volume 9, Issue 2
Biotechnology Week

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).

This week more than 300 companies are expected to deliver presentations to more than 3,500 investors at the widely followed 27th Annual JP Morgan Healthcare Conference being held at the Westin St. Francis Hotel, San Francisco, California. Starting on Monday and going through Thursday, the business newswires should be full of healthcare, pharmaceutical and biotech announcements.

Last Friday, the Financial Times reported that Roche of Switzerland would renew its offer to buy Genetech sparking a new round of speculation about more takeovers in the biotech sector.

After the market review, we offer three option suggestions for the biotech action and update the Takeover File with another Genetech suggestion. In addition, we have two financial ideas and then update the current long gold suggestion.

Market Review

S&P 500 Index (SPX) 890.35. For the week, the SPX declined 41.45 points or 4.45% as volume returned to normal levels after the holidays. It still appears to be in a counter -trend rally, from the key reversal low on November 21, 2008 so we expect a lower low sometime in the near future.

S&P 500 Index IVX 38.12. As expected, the Implied Volatility Index Mean (IVXM) turned higher last week closing up 3.71 or 10.8%. If the SPX continues lower and retests the November 21st low we should see higher volatility numbers.

US Dollar Index (DX) 82.66. With a declining equity market, we get a rising dollar, last week the increase was .82 but the potential rising wedge pattern failed to develop. Therefore, the dollar looks to be going higher once again.

NYSE McClellan Summation Index. Our market breadth indicator added another 420.60 points pushing it up above the zero line to 333.40, the first reading in positive territory since June of last year.

Strategy

Until the technical condition as defined by the Elliott wave pattern, suggesting the current rise is a counter- trend 4th wave has been resolved we suggest long positions be hedged by short ETFs, buying puts, selling calls or by collars or perhaps even a VIX bull call spread as a hedge.

This should be a busy week as earnings reporting season begins, we have January options expiration and the healthcare conference news.

IVOLopps™

Cypress Bioscience, Inc. (CYPB) 7.34. San Diego based CYPB working with Forest Labs has recently submitted milnacipran, for fibromyalgia syndrome to the FDA for approval. Analysts are positive about the prospects and if approved they expect Forest Labs will acquire CYPB.

CYPB is number one in our Top 5 ranking based on IV Index Mean vs 30D HV with a Historical Volatility of 65 and an Implied Volatility Index Mean of 207.18 for the top positive volatility spread ratio of 3.21. With a high put/call ratio of 2.5, the implied volatility has been driven higher by put buyers seeking downside protection for their long stock positions. The options have been active and there appears to be reasonable liquidity.

Consider this put sale idea with a good edge.

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about .775 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .19 for each point change in the stock price. With high implied volatility, this put is 2.34 points, or 32% out-of-the-money. If you can accept the risk that you may own the stock this put looks attractive.

Elan Corp. Plc. (ELN) 8.39. After reporting earnings on July 24, 2008 the stock declined 24.12 on the news of a regulatory filing of two new cases of a serious and often deadly brain infection in multiple sclerosis patients being treated with their Tysabri drug for multiple sclerosis. Recent call buying seems to indicate optimism that they will be providing a positive update at the JP Morgan conference. The calls have been active with the put/call ratio at .05 while the Implied Volatility Index Mean has risen to 118.66 from 89.54 in the prior week. Assuming the call buyers are on the right side of this trade consider this bull call spread.

The debit indicated above is based upon Friday’s middle closing prices between the bid and ask. Since the position has slightly positive time value, the debit Monday should be about 1.185 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .34 for each point change in the stock price.

Biotech ETFs

The selection of biotech ETFs from an options perspective is limited and only IBB has enough trading activity to be considered for options strategies. In this sector options activity seems to be focused on the specific names.

iShares Nasdaq Biotechnology (IBB) 69.18. Includes many recognized Biotech holdings.

With a current Historical Volatility (HV) of 39, consider this put sale for a bullish idea going into the JP Morgan conference.

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about .885 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .16 for each point change in the stock price.

Use a close below 65 as the SU (stop/unwind).

Financials

Morgan Stanley (MS) 19.06. Morgan Stanley formerly an investment bank and now also a commercial bank is receiving positive comments from analysts resulting from the news that they are discussing with Citigroup Inc. (C) 6.75 a potential joint venture with their Smith Barney unit. Analysts think Citi is being pressured into this by the US Treasury as a means of raising more capital. The analysts also think the combination will be advantageous for Morgan Stanley.

Morgan Stanley looks to be near resistance at 20 and since the entire financial sector remains in doubt and will take some time to improve we think this may be an opportunity to for a call credit spread.

By selling the at-the-money call and buying an out-of-the money called for protection we receive a net credit. If the stock declines as expected we will keep the net credit.

With a Historical Volatility of 123 and an Implied Volatility Mean Index of 87.52, consider this call credit spread.

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. The position is slightly positive time value, the credit Monday should be about .76 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .15 for each point change in the stock price.

Use a close above 20.80, the break-even as the SU (stop/unwind) by buying back the short call or unwinding to position.

iShares Barclays 20+ Year Treasury Bond (TLT) 112.73. This ETF seeks to duplicate results corresponding to the price and yield performance of the long-term sector of the United States Treasury market as defined by the Barclays 20+ Year U.S. Treasury index.

After reaching a 123.15 high on December 18, 2008 TLT has declined below the upward sloping trendline defined by the November 13, 2008 low at 93.25, the December 12, 2008 low at 110.34 and the December 31, low at 118.85. The quick three-point decline on January 2, 2009 was most likely caused by the Barron’s sell signal published in the January 5th edition. Then last Friday Bill Gross at PIMCO wrote that the current Treasury securities low yield “offer little reward and increasing risk.”

For those who think the funding requirements of the US Government will eventually cause interest rates to rise as more issues are brought to market thereby materially increasing the supply then TLT, with good options volume and open interest, offers an opportunity to create short positions in the Treasury security market with defined and limited risk.

The current Historical Volatility is 30 and the Implied Volatility Index Mean is 25.47.

Consider this bear put spread suggestion.

The debit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the debit Monday should be about 1.89 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .13 for each point change in the stock price.

Use a close above 120 as the SU (stop/unwind). The current TLT pattern has the look of a developing Elliott 4th wave which as the potential for a higher high than the December 18, 2008 high at 123.15. This could correspond with a final 5th down wave in the equity market equating to long treasury rates in the low 2% range. While this seems unlikely with a recovering equity market, it could be possible if equities continue lower. Recent experience has given us more respect for unlikely market developments. In the event TLT reverses and rises back above 120 close this position and wait for the next opportunity that will come in the near future as long-term interest rates start to rise.

Long Gold Update

SPDR Gold Shares (GLD) 83.92. The Trust holds gold and issues shares in exchange for deposits of gold.

Last week GLD declined from 86.23 or -2.31 corresponding to a decline in spot gold from 875.95 to 853.25. It now appears that the October rally from 70 has been a rally in a bear market and that it is now ending. The seasonal year-end strength is fading as it has failed to cross above the down sloping trendline from the July and October highs.

We now suggest closing the long Jan 80, short Jan 102 bull call spread. At mid prices on Friday, the spread was priced at 4.20. With an adjusted cost basis of 3.825 this represents a .375 gain on the original basis of 1.70 or 22% in 6 weeks, assuming the spread price on Monday will be near 4.20.

Takeover File Update

Genentech Inc. (DNA) 86.34. Last July Basel, Switzerland based drug giant Roche Holding Ltd. made an unsolicited and unexpected offer at 89 to purchase the remaining 44% of DNA that it does not already own.

DNA called the offer insufficient and the negotiation process appeared to be stalled until the Financial Times reported Friday that Roche would up the offer to 95 in early February. Analysts are still indicating something closer to 100 per share is expected so this saga may continue awhile longer.

We first wrote about the Roche bid for Genetech in IVolatility Trading Digest™ Volume 8, Issue 28, Biotech Buzz, dated July 28, 2008.

We last suggested a DNA options strategy in IVolatility Trading Digest™ Volume 8, Issue 36, The Week That Was, dated September 22, 2008. Then DNA was 92.27 and we suggested the sale of the October 90 put at 3.85. The stock closed at 83.53 on the October options expiration so the stock would have been assigned and the cost basis would be 86.15. We also assume that call options would have been sold in both November and December further reducing the cost basis.

Consider once again selling another put. The current Historical Volatility is 33 and the Implied Volatility Index Mean is 38.73.

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about 2.135 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .27 for each point change in the stock price.

This put has a reasonable edge and we do not see very much downside risk. Even if Roche were to withdraw the offer, we do not think they would do it before the February options expire.

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.

Comments:

Another great post Bud. Thanks for your insight and ideas. I have profited from your blog (Anheuser-Busch for example) and look to do as well in 2009. I am a relatively new options trader doing mostly covered calls. Unfortunately I'm not permitted to do spreads just yet, so I was wondering if a straddle would be a wise move on one of the biotech firms/ETF or one of the potential takeover targets.

Thanks,

Jim

Posted by Jim on January 11, 2009 at 07:17 PM EST

Jim,

Thanks for your comment and kind words. We do appreciate the feedback. We are expecting to see many more strategic acquisitions this year like BUD and DNA creating many options opportunities. With respect to straddles, we assume you mean long straddles, long the call and long the put, usually at-the-money. Being long both options means you are concerned with both time decay of the premium and declining implied volatility. Look for options with about three months to expiration in an effort to balance the time decay risk with the sensitivity to changes in volatility. When considering long straddle candidates it is imperative to look at the volatility chart (see Advance Historical Data) in order to make volatility forecast. Straddles are a volatility trades so this should be the focus of the trade plans. Since straddles are long two options the position is long volatility or long Vega, the rate of change of the options value with 1% change in the volatility. This data is found in the second to last column on the Advance Options page.
They are often used going into the reporting period with stocks that show a regular increase in implied volatility as their near the reporting date. When the report comes, however the excess implied volatility will disappear and both options decline in price so the change in underlying price must be large enough to overcome the decline in price due solely to the decline in the implied volatility of both options. While they are complicated, they can often be effective with a good trade plan.


With respect to their application for biotech takeovers, the same concept applies except it is more difficult to predict the exact date of the event. However, if you get into the trade early you have a better chance of capturing the rise in implied volatility. Since the buzz about potential takeover targets has already begun in the sector you will find the implied volatilities have already started to rise on the better know takeover targets.

As a reference for further details in preparing a straddle trade plan we suggest Guy Cohen’s book “The Bible of Options Strategies” FT Prentice Hall, 2005.

We trust you are one of our subscribers and are using both Advanced Historical Data for the best volatility charts in the business and Advanced Options to prepare your trade plans.

Jack

Posted by Jacktrader (68.5.48.36) on January 12, 2009 at 12:08 PM EST

JT
I have a quick question regarding selling Puts ie: CYPB for example. The Feb Put was sold at .85 and it is now @ .15 ask.The stock is 9.40. At exercise date the stock is $10.00. If I am assigned do I get the stock at $5 minus plus the premium or do I receive it at market price plus-minus the premium?
which would be more profitable?
I believe you have great insight !
Thanks
Mike

Posted by Mike S on January 15, 2009 at 08:22 PM EST

Mike,

Thanks for the question about selling puts and Cypress Bioscience, Inc. (CYPB). Last week CYPB was number one in our Top 5 ranking based upon IV Index Mean vs 30D HV that we have on our home page as a regular feature. This alerted us that something was causing the option prices to be bid higher. Upon investigation, we concluded that the upside potential exceeded the downside and suggested the put sale when the stock was last priced at 7.34. Wednesday after the close, they announced FDA approval for their Savella (milnacipran) drug for the treatment of fibromyalgia. Score another one for the call option buyers, or the put sellers in our case. We suggested the sale of the February 5 put at the Friday price of .825 or about .775 on the estimated Monday price. If you sold the option at the opening in Monday, it would have been priced about .75 after adjusting for the Monday price change at the opening. Since you sold the option, you will not be assigned unless the stock price was to decline below $5 and this does not appear to be likely. The current mid price for the Feb 5 put is .075 with a bid at .05 and ask at .10. This means that you would probably need to pay .10 to close your short put position, booking the .65 gain in less than a week. Since the good news is in the stock price it is probably best to buy it back if you have other opportunities to use the cash and margin. If not you could just let is expire next month and keep the entire .75 credit and save the brokerage commission.

Once again, out Top 5 ranking based upon IV Index Mean vs 30D HV tipped us off to another good options opportunity. If you are looking for ideas this is an easy and convenient place to find them.

Jack

Posted by Jacktrader (68.5.48.36) on January 16, 2009 at 01:52 PM EST


Permalink Comments [4]

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".