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Today


IVolatility Trading Digest™


Volume 9, Issue 45
Believe it or not!

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).
 

Believe it or not!

Last week’s upward move in the equity market back to the prior high appears encouraging for the bulls, but we see divergences and wonder if it can be believed or not. In this Issue we review one previous trade, offer another hedging idea, another shipping suggestion and then two more short put ideas for the bulls. First, our market review.

Market Review

S&P 500 Index (SPX) 1093.48. Last Monday’s 23.78-point move higher raised serious doubts about a developing Head & Shoulders Top or even a Double Top. Then, last Wednesday it continued higher to 1105.37, but closed back under 1100 at 1098.51. A close above 1100 would have greatly reduced the possibility of a Double Top formation. The SPX has a tendency to overshoot expected turning points so we remain cautious about precluding this possibility but we think the likelihood is low. In addition, once it closes above the previous resistance at 1100 as shown in our Head & Shoulders Bottom chart in Digest issue 36, it will have little overhead resistance thus clearing the way to the minimum upside measuring objective at 1233.29.

E-mini S&P 500 Future (ESZ9) 1091.50. The December E-mini future contract added another 25.25 points last week or 2.37% supported by a further expansion in the open interest as 16.554 more contracts were added through last Thursday. With the 1103.25 high on Wednesday, ESZ9 is back above the active upward sloping trendline from the March low touching pivots on July 14, 2009 and November 2, 2009 at 1026. The futures are supporting the view that SPX will most likely continue higher.

S&P 500 Index Implied Volatility (IVXM). Our Implied Volatility Index Mean declined again, this time by .65 to 20.66 and the VIX was lower by .83 to 23.36 and below the 20-day moving average.

The VIX futures were slightly higher for the week. The December future at 25.85 represents a 10.7% premium above the cash. January at 27.45 is a 17.5% premium, while February at 27.80 is a 19% premium.

The implied volatility of the VIX options were higher with the call Implied Volatility Index Mean at 98.95 an increase of 27.63. The put Implied Volatility Index mean was 97.55 or 27.68 higher. Once again, the VIX options are pricing in higher premium levels.

US Dollar Index (DX) 75.33. DX cash declined another .49 for the week and appears to be trading in a range between 75 and 76 ½. We suggested in Digest issue 42 that it might trade in this range until year-end. A breakout above the upper or a decline below the lower level would be a signal to focus on the currency exchange rates once again. In the meanwhile, there is a reasonable chance for stability until after year-end.

iShares Barclays 20+ Year Treasury Bond (TLT) 93.92. For the week TLT rose .59 points and now appears to stable in a range between 93 and 94, while being supported at 92 ½. The current level corresponds to a long-term Treasury yield of 4.35%.

NYSE McClellan Summation Index 396.80. Our market breadth index stabilized and turned slightly higher advancing 32.87 points. While the major indexes are moving higher fewer individual issues are moving higher suggesting distribution. One example considered by some to be a market bellwether is Goldman Sachs Group Inc. (GS) 176.76. On Friday, the NYSE Composite Index rose 56.75 to 7119.80, and just 1.68% below the previous high of 7241.39 made on October 19, 2009. However, GS declined 1.72 or 8.7% and below the high of 193.60 made on October 14, 2009. This could represent rotation out of financials or distribution. For now, we rate it as a caution flag. caution flag 

Baltic Capesize Index (BCI) 7183. The Baltic dry-bulk shipping rate index steamed ahead another 1600 points or 28.7% for the week approaching the previous recent high of 8147 made on June 3, 2009. Either the hedge funds are into shipping futures or there is increasing demand to move iron ore, coal and other bulk raw materials. We think the later is more likely as there are reports that stockpiles at major Chinese ports have declined. The benchmark VLCC crude oil tanker rate, MEG – Korea improved by 11 World Scale points to 49.5 indicating a daily rate increase by $17,361 to $31,876. Last week’s lower level appears to have been a temporary aberration, but we will have to wait and see if the higher level can be maintained.


Strategy

In the near term, we suggest remaining focused on the US Dollar Index and its ability to show stability in the range between 75 and 76 ½. A breakout out above 76 ½ will be a problem for both equities and commodities.

If the US Dollar Index remains stable, 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. While the potential Head & Shoulders Top pattern is no longer a concern a Double Top may still be possible. If the S&P Index continues higher and closes above 1100 it should continue, but unless it accelerates, it most likely will not reach the 1233.29 objective by year-end.

The question is, do we believe the classical technical analysis or pay more attention to the divergence between the broad indexes and the number of issues advancing compared to the issues declining? The broader based iShares Russell 2000 Index (IWM) 58.73 already appears to be declining.

Adjustments to Consider

In IVolatility Trading Digest™ Volume 9, Issue 41, Great Expectations, dated October 19, 2009 we suggested using an Iron Condor for Human Genome Sciences Inc. (HGSI) now 27.89, when it was 19.96. This was a high-implied volatility trade as the call IVs were in the 140 range and the put IVs in the 180 range.

The high implied volatility indicted the potential move could be substantial but we knew it could not be in both directions so we decided on the Iron Condor using a short call spread and short put spread.

On November 2, 2009, the stock gapped open 6.15 and closed up 6.59 for the day. The best move would have been to close the position then, but we delayed on expectations of a pull back that only came from a still higher price level. Then on November 11, 2009 we bought back the short November 25 call leg of the call spread for a loss while retaining the long November 27 ½ call, now just in the money. Since the remaining call and the put options will expire Friday, some plans need to be prepared.

If the stock is below 27 ½ the call will expire and we will book the loss and remind ourselves this is an example of why we limit the position size as a risk control method with high implied volatility positions. We will then watch the stock for a put selling opportunity on the next reversal higher.

If above 27 ½, we will exercise our long call and take the stock by assignment. Although the implied volatility has declined substantially it is still in the upper 50s so the premium levels are high enough to sell calls against the long stock. For example, on Friday the Dec 30 call was 1.185 with an implied volatility of 57.15. In addition, we can consider selling a Dec 25 put that was .91 on Friday with an implied volatility of 61.66.

For those who may be following this trade we will post a tweet on twitter Friday before the close with the action plan.

Hedging Our Longs

The divergence mentioned above is a real concern so we will add another hedge strategy to our existing long PowerShares DB US Dollar Index Bullish (UUP) 22.32 Dec 23/24 call spread. This time however we will use the index that is causing the most concern.

iShares Russell 2000 Index (IWM) 58.73.

With a current Historical Volatility of 25.11, consider this long put spread as a hedge against long portfolio positions.

Buy 2 spreads.

IWM

The mid price for this spread on Friday was a debit (Dr) of 1.52 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about the same as the time decay is offset by the spread and is shown above in the “E Price” column. The prices and Greeks shown above are based upon a single option so the values will be doubled for the two long put spreads. Use the deltas for each leg to adjust for any change in price of the underlying ETF or use the net spread delta for spread orders.

Use a close back above 62 as the SU (stop/unwind) in the event the SPX closes above 1100 and the market breadth improves.

IVOLopps™

Dry Bulk Shipping

Dry Bulk Shipping

Based upon the continuing strength of the Baltic Dry Bulk shipping Indexes and in particular the Capesize Index for the larger ships we suggest one additional position.

DryShips, Inc. (DRYS) 6.85. Athens based DRYS is a shipping company that is more levered both financially and to rising spot prices than some other shipping companies, but it has the advantage of active options with large volume and open interest.

With a current Historical Volatility of 61.38, consider these long call spreads.

Buy 5 spreads.

DRYS

 The mid price for this spread on Friday was a debit (Dr) of .33 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about the same as the time decay is offset by the spread and is shown above in the “E Price” column. The prices and Greeks shown above are based upon a single option so the values will be doubled for the two long call spreads. Use the deltas for each leg to adjust for any change in price of the underlying ETF or use the net spread delta for spread orders.

Use a close back under 6 ½ as the SU (stop/unwind).

Natural Gas Wildcatter

I

This is one we first suggested in IVolatility Trading Digest™ Volume 7, Issue 15, May Expiration Review and Looking for More Deals, dated May 21, 2007 and then again, in IVolatility Trading Digest™ Volume 7, Issue 24, Infrastructure, dated July 23, 2007. Then again in IVolatility Trading Digest™ Volume 9, Issue 37, Too Far Too Fast? dated September 21, 2009, we suggested a call ratio backspread.

InterOil Corp. (IOC) 51.72. InterOil Corp. engages in the exploration and production of oil and gas properties in Papua New Guinea.

After consolidating from the recent breakout it appears, it will continue higher.

With a current Historical Volatility of 80.23 and with the Implied Volatility Mean Index of 81.08 consider this short put sale as an alternative long strategy.

IOC

The mid price for this put sale on Friday was a credit (Cr) of 2.55 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be 2.36 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.

Use a close below the last pivot at 45 as the SU (stop/unwind).

A Bit More Gold

Although the divergences mentioned above are a reason to be cautious there is a positive seasonal gold tendency and it should last until the end of December. Several of last week’s suggested model portfolio put sales were greatly reduced in value by the time they were implemented at the close last Monday as the SPX was up 23.78. Here is one more we suggest increasing based upon the seasonal strength.

Compania de Minas Buenaventura SA (BVN) 37.28. BVN is Peruvian precious metals mining company producing gold, silver, zinc, lead, and copper.

There are several reasons to be cautious about this suggestion including the divergence mentioned above creating market risk and if the market opens down significantly on Monday, we will withdraw this idea. Additional risks include a possible double top and the options are thinly traded meaning increased slippage. While there appears to be good support at 35, a close below that level would mean assignment of stock at the end of the gold season raising the chances of a long holding period. With these qualifications, here is the put sale we suggest with a positive market Monday.

BVN

The mid price for this put sale on Friday was a credit (Cr) of 1.40 as shown in the “Price” column above. Adjusting for time decay the estimated price on Monday should be about 1.21 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.

Use a close below the support at 35 as the SU (stop/unwind).

Be Cautious

CAUTION

As noted above extra caution is warranted on the bull side until the divergence issue is favorably resolved. Further, the potential double top is the SPX has not yet been completely resolved.



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In next week’s issue, the S&P 500 Index direction issue will most likely be resolved and we will follow its direction.

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".