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Today


IVolatility Trading Digest™


Volume 9, Issue 40
Quarterly Report Mania

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).
 

State of Mania

According to the Random House Dictionary combining mania with the specified initial element, for example bibliomania, the result means “enthusiasm, often of an extreme and transient nature.” The upcoming earnings reports are likely to be enthusiastic, perhaps extreme and probably transient. While the reports accelerate into a mania and we offer a new equity market long suggestion, three volatility spread ideas, and one more shipping company. First, we review our market indicators.

Market Review

S&P 500 Index (SPX) 1071.49. Last week SPX recovered 46.28 of the 60.20 points that it lost in the previous two weeks returning to, but not back above the active upward sloping trendline. The next few days will be an important test of the trendline. We think it will most likely continue higher, cross back above the trendline and resume climbing toward the upside measuring objective at 1233.29, from the large Head & Shoulders bottom that we explained in Digest issue 36, although we have a few concerns that we explain in the sections below.

E-mini S&P 500 Future (ESZ9) 1068.00. For the week the December E-mini future contract was 46.25 or 4.5% higher. However, volume was light and from Thursday through Thursday, open interest declined by 5,857 contracts and for the past two weeks, the decline was 10,770 contracts. For the bull market to continue the E-mini needs to continue higher crossing back above the trendline with increasing volume and increasing open interest as it advances. The E-mini is not showing the enthusiasm we would expect.

S&P 500 Index Implied Volatility (IVXM). Our Implied Volatility Index Mean was lower by 4.88 at 20.48 while the decline in the VIX was 5.56 to 23.12. The VIX 20-day moving average at 24.84 is once again above the current VIX. Since June, this is the fourth time the VIX has spike higher only to close the week below the 20-day moving average.

The risk premium measures were all significantly higher last week. The October VIX futures premium over cash increased 12.60 to 6.2%, but it should be rapidly declining as it is about to expire. The November premium increased 14.2 to 14.6% and December increased 15.9 to 17%. These higher risk premiums indicate some caution is warranted until SPX crosses back above the active upward sloping trendline.

Confirming the futures premiums the implied volatility of the VIX calls shows a similar increase. The October 25 calls increased to 101.13 from 80.76 and the November 25 calls increased to 114.35 from 61.70. This means a greater willingness to pay higher premiums for a potential rising VIX as hedging strategies.

US Dollar Index (DX) 76.43. DX reversed last week’s small uptrend after reaching 77 ½ and then declined .57 on the week as equities, gold, silver and commodities turned higher. Looking at the chart, there is now a small double bottom at 76 with the potential to take DX all the way back up to 79. This would give gold an opportunity to pull back from the breakout to new highs. It would also cause problems for SPX as it attempts to cross back above the upward sloping trendline.

iShares Barclays 20+ Year Treasury Bond (TLT) 95.90. The rise in the long bond ended as TLT declined 3.11 or 3.14% for the week closing below the previous upward sloping trendline. Some attribute this decline to greater risk preference, while others cited a weaker than expected Treasury auction. The greater risk preference alternative would be supportive for equities and commodities.

NYSE McClellan Summation Index 1152.87. As the broad equity market recovered from the minor correction, breadth, defined as NYSE advancing issues minus declining issues, lagged as it declined 55.73 for the week creating a divergence, meaning fewer stocks participated in the recovery from the prior week’s correction low.

Baltic Capesize Index (BCI) 4107. For the bulls, BCI was the star of the week. (STAR!) This long route dry-bulk shipping index increased another 825 points or 25%. In the past two weeks, it has now risen 1,430 points or 53.4%. While we have no evidence, we suspect it is not being driven higher by index ETFs and hedge funds. This could be indicating a real improvement in bulk shipping demand. In response, we offer an additional suggestion for long dry-bulk shipping below.

Strategy

Once again, the focus is on the US Dollar Index. If 76 holds it may create a double bottom with a potential rise to 79. This will make it difficult for the S&P 500 Index to cross back above the upward sloping trendline. In addition, it will give gold the opportunity to pull back on profit taking from its new all time high.

Other concerns for the S&P 500 Index include the weaker E-mini volume and declining open interest, rising risk premiums in the VIX futures and options implied volatility along with the divergence in market breadth, all detailed above.

With these thoughts in mind, we have a new long suggestion for iShares Russell 2000 Index (IWM) 61.42.

While the equity indexes appear to be resuming the uptrend, we prefer a position that benefits from higher equity prices without significant downside risk and a call ratio backspread for a credit is one alternative that should do the job. The current Historical Volatility is 21.58. Here are position legs.

IWM

The mid price for this spread on Friday was a credit (Cr) of .975 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be 1.01 as shown above in the “E Price” column. Use the deltas for each leg to adjust for the change in prices of the underlying or use the net spread delta for spread orders. Note the buy for the Nov 65 calls is 2 options, priced .76 each on Friday and should be about .70 each on Monday before adjusting for any price change in IWM. The Greeks reflect the totals for the long 2 Nov 65 calls and short the Nov 61 call. The estimated credit before any underlying price change is 1.01.

Since the position has negative theta, we want the index direction to be determined soon and we plan to close it in two or three weeks since we do not want to lose a lot of time value.

IVOLopps™

Quarterly Earnings Reports

Using our RT Spread Scanner set to find implied volatility differentials we ran a scan looking for stocks with high near term implied volatility before reporting earnings. Here is one that reports on Tuesday.

Intel Corporation (INTC) 20.17. The current Historical Volatility is 24.67

INTC

This could be a calendar spread candidate, buying the Nov 21 call and selling the October 21 call, but since it is near to being in-the-money we decided for a less complicated strategy with does not involve a potential short in- the-money call at expiration on Friday.

Here is an alternative put sale that also has a good implied volatility edge. In addition, if the stock declines after reporting we would take in the stock by assignment and then sell calls in the next months.

We suggest selling two puts. Here is the data for each one.

INTC

The mid price for this put sale on Friday was a credit (Cr) of .47 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .37 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.

INTC reports on Tuesday, expectations are for .27 per share and the options expire Friday.

Here is another from the RT Spread Scanner.

Safeway Inc. (SWY) 21.32. SWY is the supermarket chain in the US, Australia, Canada and Mexico.

They report on Thursday and expectations are for .30 per share.

The current Historical Volatility is 20.52.

Here is the scan result. Note below the implied volatility differences (33.34% and 48.81%).

USO


The mid price for this spread on Friday was a debit (Dr) of .275 (1.75- 1.475). Adjusting for time decay the estimated price on Monday should be .32 (1.72-1.40). Use the deltas for each leg to adjust for any change in the price of the stock or use the net spread delta of -8.98 for spread orders.

If the stock trades higher or stays the same there will be a management concern on Friday since our short call will be in-the- money. In that event, we will buy 100 shares of stock Friday using a market on close order. This will make us long 100 shares to deliver against our short October 20 call. On Monday, we will then see about selling the long November 20 call.

Here is one more from the RT Spread Scanner.

DepoMed Inc. (DEPO) 6.36. DepoMed, Inc. is a specialty pharmaceutical company developing pharmaceutical products based on its proprietary oral drug delivery technologies. One analyst is excited about the recent positive phase III data for DM-1796 in PHN and believes the market has yet to factor in the potential this drug has in terms of delivering milestones and royalties to the company from partner Abbott Labs.

With current Historical Volatility of 89.43, consider this high-implied volatility (161.94) put sale.

DEPO


The mid price for this put on Friday was a credit of .675 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be .63 as shown above in the “E Price” column. The “Greeks” are 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.

Use a close back down at 4 ½ and below the recent gap as the SU (stop/unwind)

GENCO


As the Baltic Capesize Index continues higher here is another dry- bulk shipping idea to consider.

Genco Shipping & Trading Ltd. (GNK) 21.88. Genco transports iron ore, coal, grain, steel products, and other dry-bulk cargoes. As of December 31, 2008, Genco owned and operated a fleet of 32 ships, including 6 Capesize, 8 Panamax, 4 Supramax, 6 Handymax, and 8 Handysize carriers, with an aggregate carrying capacity of approximately 2,396,500 deadweight tons. With the current Historical Volatility of 57.44, consider this combination of a short put and long call spread.

Part one – put sale.

GNYWT

The mid price for this put sale on Friday was a credit (Cr) of 1.25 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be 1.18 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.

GNKAA

The mid price for this spread on Friday was a debit (Dr) of 1.10 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be 1.09 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.

Use a close below the last pivot at 19 as the SU (stop/unwind).

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


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In next week’s issue, we should have the answers to our equity index concerns. In addition, we should know if gold is going to correct giving us a buying opportunity. We will also look for more earnings report ideas.

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.

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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".