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Today


IVolatility Trading Digest™


Volume 9, Issue 39
Smooth Sailing

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).
 
Smooth Sailing

After the moderate equity market correction, we look at our indicators for some clues about the likely short-term direction. We want to know if this correction over and if the market is about to turn upward creating smooth sailing conditions into year-end. We start with the third quarter portfolio report and then a portfolio adjustment, followed by a new volatility hedge, a crude oil renewal idea and while we are on the subject of on sailing, we have a shipping suggestion. First, our market review.

Market Review

S&P 500 Index (SPX) 1025.21. SPX continued lower last week by another 19.17 points or 1.8%. From the key reversal high at 1080.15 on September 23, 2009 to Friday’s low SPX has declined 60.20 points or 5.6%. Last Thursday it closed below the active upward sloping trendline from the low on July 10, 2009 at 872.81 crossing at the low of 992.25 on September 3, 2009, creating a real concern that the decline will continue as it is now below the trendline. Two weeks ago, we suggested the SPX had risen too far too fast, now we wonder if the correction has gone far enough.

While we still maintain our upside measuring objective at 1233.29, from the large Head & Shoulders bottom previously explained in Digest issue 36, first we need to see this correction end.

E-mini S&P 500 Future (ESZ9) 1021.75. The December E-mini future contract declined another 19.25 points or 1.9% last week. From Thursday to Thursday, open interest declined by 15,730 contracts, not enough to cause concern. For the bull market to continue the E-mini needs to turn up and cross back above the trendline with increasing volume and increasing open interest as it advances.

S&P 500 Index Implied Volatility (IVXM). Our Implied Volatility Index Mean was up 2.61 at 25.36 while the VIX increased 3.07 to 28.68. The VIX 20-day moving average, our hedge indicator is our now 24.69 and below the current VIX at 28.68 calling for a VIX hedge.

While the VIX turned higher, the premium measures all declined creating a mixed signal. The October VIX futures premium over cash declined 11.83 to a negative 6.4%. The November premium declined 11.08 to just .4% and December declined 9.6 to 1.1%. The low futures premiums over cash are indicating the market is about to reverse and turn up once again.

The implied volatility of the VIX October calls is showing a similar pattern. The October 25s declined to 80.76 from 99.83 the prior week. The October and November at-the-money calls are now in the 60 to 70 range down significantly in the last two weeks indicating less willingness to pay higher premiums for a rising VIX suggesting the current rise will not be sustained.

US Dollar Index (DX) 77.00. DX continues trending higher adding another .19. Now in a defined uptrend it could continue up to resistance at 78. This will keep pressure on equities, commodities, including crude oil, gold and silver. Watch as it approaches 78 for signs of weakness and signs of strength in the sectors now declining. A reversal in this trend would activate the resumption of the equity and commodity uptrends.

iShares Barclays 20+ Year Treasury Bond (TLT) 99.01. With another increase of 1.03 or 1.05%, TLT, like the US Dollar Index, is also in a well-defined uptrend from the double bottom low made on August 10, 2009 at 90.41. Rising long bond prices are now consistent with declining equities and commodities, associated with lower risk preferences.

NYSE McClellan Summation Index 1208.60.  Breadth, defined as advancing issues minus declining issues, is following the market lower as our indicator accelerated to the downside last week by 217.53 points after making a new trend high two weeks ago.

Baltic Capesize Index (BCI) 3282. The long route dry-bulk shipping index declined to a low of 2545 on Wednesday September 23, 2009 and then turned higher adding 737 points or 29% over the next 7 trading days. Assuming the trend is sustainable, it provides additional evidence that the equity correcting may soon be ending. We are now removing the yellow caution flag that has been flying for the last several weeks and even suggest a long dry-bulk shipping strategy below.

Strategy

The focus is now on the US Dollar Index and the foreign currencies against the dollar. As equities and commodity positions were unwound, the dollar and Treasury bonds increased. The US Dollar Index could rise to 78 before encountering resistance that could mark the turning point for both equities and commodities. While there is some support for SPX at 1025 the more likely turning point would be at 1000, which could correspond with the US Dollar Index resistance at 78.

When we see the dollar begin to decline, we will renew long equity, gold and silver positions.

OOR TRACK RECORD

As of September 30, 2009, our record of closed and open positions marked- to- market, after commissions, for nine months was a net gain of $8,926.43, up $916.40, or 11.4% from the end of June. During the quarter, we had an average initial margin requirement of $10,232 with an August10, 2009 high of $14,393 and a July 17, 2009 low of $7,691. Based upon the average margin requirement for the quarter, the return on investment was 9%.

Using the initial investment of $30, 000 before adding the gains from closed positions, the portfolio was on average 34% invested during the quarter.

As of September 30, 2009, the portfolio consisted of 26 option leg combinations and 1 long stock position in 13 different stocks and ETF’s.

On a risk-adjusted basis, the return is even more favorable considering most positions, with few exceptions, have limited and defined levels of price risk.

Portfolio Adjustment

From IVolatility Trading Digest™ Volume 9, Issue 35, More Gold and Silver, dated September 8, 2009, here is one position to close since we did not allow enough time upon making the original suggestion. With negative theta or time value that is now accelerating, while the stock is locked into a range it should be closed.

Citigroup, Inc. (C) 4.52.

C

The mid price on Friday was a debit (Dr) of .485 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about .50 shown above in the “E Price” column.
The prices and Greeks are for one option, therefore 2 Oct calls should be about 1.12 and the 4 Oct 5 calls should be about .24, for a net debit of .88. ((.56 x 2) – (.06 x 4)). Use the deltas for each leg to adjust for any change in the stock price or use the net spread delta for spread orders.

Volatility Hedge

As we noted in IVolatility Trading Digest™ Volume 9, Issue 24, Seasonality in Volatility, dated June 22, 2009, market implied volatility has a seasonal tendency to rise in October.

Although the volatility risk premiums have declined dramatically as described in the S&P 500 Index Implied Volatility section above, we suggest following the volatility game plan based upon the VIX closing above its 20-day moving average.

CBOE Volatility Index (VIX) 28.68.

With a current Historical Volatility of 64.03, here is a long call spread idea.

VIX

The mid price for this spread on Friday was a debit (Dr) of 1.225 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be 1.13 as shown above in the “E Price” column. Use the deltas for each leg to adjust for any change in the price of the stock or use the net spread delta for spread orders. Since we are expecting the implied volatility to rise, we want a position with long Vega. We selected November over October although it has lower Gamma it also has lower Theta or less time decay.

Use a close back below the 20-day moving average as the SU (stop/unwind). On the upside watch for intraday spikes associated with reversals in the index for a signal to close the position.

Seasonal Crude Oil

This is a suggestion we made last week in IVolatility Trading Digest™ Volume 9, Issue 38, Oil Bears Return, dated September 28, 2009. We unwound the positions as it closed above our SU limit at 36 on September 30, 2009. We return this time with one part modified put ratio backspread suggestion.

United States Oil (USO) 35.87.

USO

B2 on line two is to buy 2 Jan 30 puts at 1.225 each, total of 2.45, as shown above. The Delta, Gamma, Theta and Vega values are also for the 2 puts.

The mid price for this spread on Friday was a credit (Cr) of .15 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .16 as shown above in the “E Price” column. Use the deltas for each leg to adjust for the change in prices of the underlying ETF.

Use a close above the downward sloping trendline now at 37 as the SU (stop/unwind)

IVOLopps™

Shipping Index Turns Higher

Here is a suggestion based upon the improving dry bulk-shipping index in the Market Review section above.

Diana Shipping Inc.

Diana Shipping Inc. (DSX) 12.61. Diana is a dry bulk shipper of iron ore, coal, grain, and other materials on worldwide shipping routes. As of December 31, 2008, its fleet consisted of 13 Panamax dry bulk carriers and 6 Capesize dry bulk carriers with a combined carrying capacity of approximately 2 million deadweight tons. With an improving dry-bulk shipping index and with expected lower crude oil prices that will translate into lower bulk fuel prices here is a combination suggestion. The current 30-day Historical Volatility of the stock is 44.09.

Part one – Sell 2 Nov puts.

DSX

The prices and “Greeks” shown above are for one put sale. The suggestion is for two so the prices and Greek values will double.

The mid price for this put sale on Friday was a credit (Cr) of 1.00 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .98 as shown above in the “E Price” column. The other “Greeks” are also based upon Friday numbers, before the position is established, and will reverse when the put is sold. Use the delta as shown above to adjust for any change in the stock price.

Part two – Long Call Spread.

DSX

The mid price for this spread on Friday was a debit (Dr) of .90 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .89 as shown above in the “E Price” column. Use the deltas for each leg to adjust for any change in the price of the stock or use the net spread delta for spread orders.

Using the estimated Monday prices the combined values (reverse x 2 for the put values shown) for both positions are:

Net Debit 1.07
Delta 116.26
Gamma -28.92
Theta 1.93
Vega -3.37

The total initial margin based Monday’s estimated prices is $815.40, $678.40 for the 2 short puts and $137 for the long call spread.

Use a close below the 12 support as the SU (stop/unwind). In addition, watch the Baltic Capesize Index. If it turns lower, once again we suggest adjusting or unwinding.

Twitter Visit us on twitter for more ideas from our scanners and portfolio updates, including positions closed or unwound during the week. 

IVolatility.com IVolatility.com Bookstore. In addition to the vast number of articles and information on our web site, browse in our bookstore for more reference information and material.

In next week’s issue, since volatility premium and market direction were again the focus of this Digest we will begin looking at third quarter earnings ideas that we intended to start this week.

Previous Issues and Reader Response Request

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:

On today's USO, you're expecting by Jan 10, USO will be below 26?

Posted by Nathan on October 05, 2009 at 10:13 AM EDT

As of September 30, 2009, the portfolio consisted of 26 option leg combinations and 1 long stock position in 13 different stocks and ETF’s.

On a risk-adjusted basis, the return is even more favorable considering most positions, with few exceptions, have limited and defined levels of price risk.
----------------------
Great!

Is there a webpage where one can see these positions ?

Thanks

Posted by JackieGL on October 05, 2009 at 10:32 AM EDT

I note below some of the very definite conclusions that you came to in your recent analysis. This is certainly a breath of fresh air in an industry noted for "hedging ones bets".

S&P 500 Index Implied Volatility:
1) The VIX 20-day moving average, our hedge indicator is our now 24.69 and below the current VIX at 28.68 calling for a VIX hedge.
2) The low futures premiums over cash are indicating the market is about to reverse and turn up once again.
3) The October and November at-the-money calls are now in the 60 to 70 range down significantly in the last two weeks indicating less willingness to pay higher premiums for a rising VIX suggesting the current rise will not be sustained.

However, having said that, is there any explanation or educational information at your website or elsewhere that would explain your rationale for coming to these conclusions?

Posted by 74.33.202.26 on October 05, 2009 at 01:51 PM EDT

Nathan,

Thanks for the USO. We have not identified a specific downside target with this suggestion. It looks to be in the early stages of a downtrend, with each rally peaking lower than the previous one. However, this would change on a close above 37. In this event, with the credit spread, we could close the position or just let them expire and keep the credit. With the seasonal tendency we don’t think this is very likely, but it does limit the upside risk in the event something happens to cause an unanticipated spike higher. The put ratio backspread does have negative theta or time value so we wanted to limit this by using January options, giving us enough time to see if the seasonal returns again this year as expected.

Jack

Posted by Jacktrader (72.193.214.145) on October 05, 2009 at 03:27 PM EDT

Jackie,

Thanks for the portfolio question. Now we have it on a spreadsheet and we planning to have it on a web page before very long. If you would like the spreadsheet, just e-mail support and ask them to send it. Watch twitter for updates and adjustments made during the week.

Jack

Posted by Jacktrader (72.193.214.145) on October 05, 2009 at 03:37 PM EDT

JohnRF,

Thanks for the comment and question on VIX forecasting. The data is on various web sites, including the CME, CBOE and our own. We maintain a log of the VIX Futures Premiums and the VIX implied volatility data. From experience, we think there is a good relationship between this data and the near term market direction with high premiums indicating a correct is likely and low premiums indicating the inverse. It is important to keep in mind the premiums change materially on a daily basis.

Jack

Posted by Jacktrader (72.193.214.145) on October 05, 2009 at 03:48 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".