« November 2009 »

IVolatility Trading Digest™

Volume 9, Issue 44
Spreading Fertilizer

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Spreading Fertilizer

Our feature this week is an idea for participating in the long three-way battle that has been raging in the fertilizer sector. While our suggested spread may not resemble the one shown above it does provide a low risk opportunity to participate if this corporate struggle is concluded in the near future. Then we have several more put sale suggestions in abbreviated table formats. We begin by reviewing our market indicators.

Market Review

S&P 500 Index (SPX) 1069.30. After declining to 1029.38 last Monday, SPX turned higher making a pivot and continued to close up 33.11 points or 3.2% for the week. The next challenge is to continue beyond 1075 since a decline now would be a set up for a Head & Shoulders Top formation. Then continuing above 1075 the next challenge will be the previous resistance high at 1100. In the meanwhile, we quote from last week. “While maintaining our minimum upside measuring objective at 1233.29, from the large Head & Shoulders bottom explained in Digest issue 36, there is now a genuine concern that the resistance at 1100 will turn into a near term market top.” A retreat now from either 1075 or 1100 will define in technical terms, a potential Head & Shoulders or Double Top.

E-mini S&P 500 Future (ESZ9) 1066.25. The December E-mini future contract rebounded 33.25 while the open interest continued expanding by another 42,279 contracts through last Thursday. From this perspective, the rebound is encouraging for the bulls although it remains below the active upward sloping trendline.

S&P 500 Index Implied Volatility (IVXM). Our Implied Volatility Index Mean declined 4.74 to 21.31 and the VIX was lower by 6.5 at 24.19 and once again below the 20-day moving average of 24.40.

The VIX futures rebounded back to more familiar premium levels. The November future at 25.10 is above the cash by 13.05%, while December at 26.40 is an 18.84% premium and January at 27.00 represents a 20.53% premium.

The implied volatility of the VIX options also declined with the call Implied Volatility Index Mean at 71.32 while the puts are back into a more normal range of 69.87. It seems last week’s skew was indicating market participants were anticipating the SPX was about to reverse higher and they had priced the options accordingly.

US Dollar Index (DX) 75.82. After a small .48 decline, DX may stabilize near the 76 level as we suggested Digest issue 42 as higher long- term interest rates are adding some support while it remains the key to higher equity and commodity prices.

iShares Barclays 20+ Year Treasury Bond (TLT) 93.33. Last week’s decline of 2.45 points corresponds with an increase in long- term interest rates to 4.39% providing support for the US Dollar Index. The yield now appears to be trending higher from the low of 3.89% made on October 2, 2009, but it is still below 4.84% from June 11, 2009.

NYSE McClellan Summation Index 363.93. Our market breadth index declined another 229.51 points for the week as the market deteriorated further, but at a slower rate while showing signs that it may begin to improve as the NYSE Composite turned higher. A failure of the advance- decline line to follow the NYSE higher would indicate a further divergence and suggest distribution was under way.

Baltic Capesize Index (BCI) 5583. This Baltic dry-bulk shipping rate index added another 536 points or 10.6% as it accelerated higher. However, the benchmark VLCC crude oil tanker rate, MEG – Korea told a different story for the tanker market as the rate for his route dropped from World Scale 47.5 to 38.5 indicating a daily rate decline from $29,362 to $14,515. This suggests the lower level of crude oil shipping demand may be reflecting lower production due to higher current inventory levels.


Remain focused on the US Dollar Index and its ability to show stability in the range around 76. Without the help of a declining dollar, equities and commodities are more dependent upon their respective supply and demand fundamentals. Seasonally gold is now strong and it should remain strong until late December.

If the US Dollar Index stabilizes, which we think is likely, the S&P 500 Index will lose one of its primary drivers and will have to rely more upon portfolio performance demand. As we mentioned above there is now a potential topping pattern developing that could become a Head & Shoulders Top. Watch 1075 and then 1100 for an indication if this index can continue higher without the help of a declining dollar. The broader based iShares Russell 2000 Index (IWM) 58.08 already appears to be declining having set off a double top pattern on this last decline.

Takeover File


The continuing fertilizer story begins in January when CF Industries Holdings, Inc. (CF) 79.05 made an offer to acquire Sioux City, Iowa based Terra Industries Inc. (TRA) 36.10. Then in February Agrium Inc. (AGU) 50.11 made an offer to acquire CF. Since then a three party battle has been going on, as neither TRA nor CF wants to be acquired at the prices that have been offered.

While we do not intend to get deeply involved in all the maneuvers it does appear that a resolution may be near. In a letter to shareholders in preparation for a meeting on November 20, 2009 Terra makes its case by claiming a value of $51.55 per share. As a result, TRA has just risen from 31 and the options implied volatility is also rising as shown below in an Advanced Historical Volatility chart.


Up from 37 and now at 52.50 it looks as if the implied volatility will continue rising.

In addition, here is the current put call ratio chart.


The orange bullish line at .3 as shown above and the current reading even less, indicating most of the recent volume has been calls.

The current Historical Volatility shown in the upper chart is 42.64 and since the Implied Volatility is rising, we want to use a strategy with positive or long Vega to benefit from any continuing rise in implied volatility.

Since this battle has been in progress for eleven months, we do not want to underestimate the time required to reach a conclusion, either friendly or hostile. As a result, we have decided to use the March 2010 options. Since we want a long strategy with defined and limited risk and long Vega with minimal time decay loss, we suggest considering a call ratio backspread, short an at-the-money call option and long two out- of-the- money calls in the same expiration month. Here is our suggested fertilizer spread set up.


The mid price for this spread on Friday was a credit (Cr) of .25 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about .28 as shown above in the “E Price” column. Notice on line two above showing the purchase of 2 March 40 calls, each were 1.975 on Friday and they are expected to be about 1.94 each on Monday. 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.

Since this is a credit spread we are less concerned with a downside SU (stop/unwind) as we are with the time to expiration. If TRA is able to get anything near to the $51.55 that they are claiming before the March options expiration this should be a profitable trade.

More Short Put Ideas

Here are two more short put trades to consider on stocks that are scheduled to report earnings this week. Do the fundamental work, check the put/call ratios, volume traded and other important variables. Set stop/unwind levels or make the decision to take the stock by assignment when placing the orders. Generally, we only suggest put sales on stocks that we would consider having in our model portfolio in the event they are below the strike price at the expiration of the option. From a put sellers perspective they are all priced with attractive implied volatility numbers as shown in the IV columns below.

These suggestions are made on the presumption that the S&P 500 Index will continue higher and overcome the current potential topping pattern. If weakness develops as described above in the strategy section we will begin the process of selectively closing these trades.


The mid prices for these put sales on Friday were credits as shown in the “Price” column above. Adjusting for time decay the estimated prices on Monday should be 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.

Here is another, this one is scheduled report earnings in two weeks.


Here are a few more that have already reported earnings or are not showing the next scheduled earnings report date.


The mid prices for these put sales in the two tables above on Friday were credits as shown in the “Price” column above. Adjusting for time decay the estimated prices on Monday should be 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.

All of the above put sale suggestions are based upon the premise that the S&P 500 Index does not make a topping pattern in the near future.

If you would like more details on any of the these ideas send an e-mail using the blog response form at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.

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

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

In next week’s issue, we will continue watching for signs that the S&P 500 Index may be topping. In the event it continues higher, we will offer more long suggestions. Otherwise our attention will shift to hedging strategies.

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".