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Today


IVolatility Trading Digest™


Volume 9, Issue 4
Refinery Time

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 is the time of the year to look at the refinery stocks to see if they will be able to expand their operating margins going into the spring inventory buildup. We have two ideas using options for this opportunity.

First, we add some details to Friday’s Trend Analysis selection in the gold mining group and offer one more suggestion resulting from the upside move in gold last Friday.

Then we close with another new addition to the Takeover File. First, a brief market review followed by some strategy thoughts.

Market Review

S&P 500 Index (SPX) 831.95. Another weekly decline for the SPX, this time it was 18.17 points or 2.14%. We are now seeing the development of the anticipated Elliott 5th wave down. While it may take some time to be completed, it would result in a new low below November 21, 2008 key reversal low. From the symmetrical triangle bearish continuation pattern that began last October, we are using 690 as the estimated measuring objective.

S&P 500 Index IVXM 41.06. The Implied Volatility Index Mean (IVXM) continued higher for the third week adding another 1.19 points or about 3%. We can expect to see higher IVXM readings once again as the SPX declines to retest the November 21st low.

US Dollar Index (DX) 85.58. The DX continued higher again this week adding 1.53 or another 1.82% as the inverse correlation with the equity market continues. Many analysts attribute this somewhat abnormal relationship to risk aversion and liquidity preference in this uncertain market environment.

iShares Barclays 20+ Year Treasury Bond (TLT) 107 69. This ETF seeks to duplicate 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. Our star this week was TLT with five down days without a pause resulting in a 6.61point decline, meaning long-term Treasury bond rates rose from their abnormally low yield level. In IVolatility Trading Digest™ Volume 9, Issue 2, Biotechnology Week, dated January 12, 2009 we suggested a long March 110 put and a short the March 105 put creating a bear put spread when TLT was priced at 112.73. We have been expecting Treasury rates to rise with an improving equity market so this week’s decline along with the decline in equities is abnormal and noteworthy. We will continue watching TLT and include it in the Market Review section as our interest rate indicator.

NYSE McClellan Summation Index. For the second week, our market breadth indicator declined once again as the downward momentum appears to be to increasing. It was lower by 134.37 points ending in still positive territory at 143.63 as once again the number of New York Stock Exchange decliners exceeded the gainers.

Strategy

Until the SPX retests and perhaps exceeds the November 21st low in an Elliott 5th wave down pattern, we remain cautious. The expected decline could take some time and it will most likely be interrupted by several rallies that will most likely just fade away as the SPX continues trudging lower. If this is the pattern that unfolds it would confirm the necessity to hedge longer investment positions by using puts, collars, spreads or a VIX bull call spread.

IVOLopps™

Gold Again

Friday in an unusual move to the upside that may have been related to the decline in long-term US Treasury bonds, mentioned above, the SPDR Gold Shares (GLD) 88.53 added 3.95 as Comex cash gold added 42.85, settling at 899.62. The Comex February Gold (GC/09G) futures contract was up 37 to settle at 895.80. While GLD did break out above the first downward sloping trend line we remain dubious and note there is resistance at the 90 level from four previous tests in September and October of last year. We think this will be just another test of the 90 level and it too will fail.

Newmont Mining Corp. (NEM) 44.44. Since NEM is Friday’s Stock Trend Analysis selection in the Options Data Analysis and Rankers and Scanners sections on our home page, we offer this suggestion while keeping in mind our skepticism about the current breakout. As GLD is about to test previous resistance, the same is true for the big gold miner NEM as it tests resistance at 45. With a current Historical Volatility at 70, consider selling this call spread.

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 1.89 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .17 for each point change in the stock price.

If we are right and NEM fails at 45 once again then our credit spread will expire at the March expiration and we will keep the credit indicated above. In the event we are wrong about the current gold market and NEM breaks out above 45 on substantial volume we suggest using a close above 45 as the SU (stop/unwind).

Yamana Gold, Inc. (AUY) 7.72. Based upon the possibility that we could be wrong about gold we are suggesting another combination in the event the current trend does continue above the previous resistance levels. For AUY this resistance level is at 8. We have previously suggested AUY as mid-sized growth gold mining company and we return once again based upon a recent Credit Suisse research report suggesting AUY could be an acquisition target for Kinross Gold Corp. (KGC) 18.23.

By using a call ratio backspread, we add a credit hedge for our NEM position while adding another takeover candidate to our active list. Currently the Historical Volatility is 81 while the Implied Volatility Index Mean (IVXM) is 84.84.

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 the same as the time decay is offset in the spread. Use the position net delta shown above to adjust for any stock price change or about .07 for each point change in the stock price.

With the extra long call, the position is helped by a rising stock price and with increases in implied volatility, but it has negative time decay so we want the position to increase in value quickly. If it is the target of takeover bid implied volatility should rise. Use a decline in the Implied Volatility Index Mean (IVXM) below 80 or no change in the stock price for 15 days as the SU (stop/unwind).

Refinery Time

Since November, one of the best performing stocks in the S&P 500 Index is the independent refiner Tesoro Corporation (TSO) 15.49. The stock price has risen from 6.71 on November 20, 2008 to the current price of 15.49, a 131% gain. Some of the gain can be attributed to improving margins as indicated by the crack spread but increased retail prices are most likely a better explanation. As the major integrated oil companies cut back refinery production at the end of year the decreasing gasoline supplies have allowed the independent refiners to charge independent retailers more for their output and this in turn allowed the major integrated companies to follow the retail market price higher. The result is greater profits for everybody on the marketing side of the business and higher stock prices for the independent refiners. In some regions, retail pump prices are fifty cents per gallon higher since mid December.

With a current Historical Volatility of 82 and an Implied Volatility Index Mean (IVXM) of 81.48, consider this call ratio backspread suggestion that gains in value with a rising stock price.

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 .855 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .04 for each point change in the stock price.

Because time decay and declining implied volatility are detrimental to this position use a decline in the Implied Volatility Index Mean (IVXM) below 75 or no change in the stock price for 15 days as the SU (stop/unwind).

Valero Energy Corp. (VLO) 24.59. VLO is the second of our independent refiner’s suggestions with a stock price increase from 13.94 to 24.59 since November 20, 2008, a gain of 76%. With a current Historical Volatility of 73 and an Implied Volatility Index Mean (IVXM) of 70.85, consider one more call ratio backspread.

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 .24 f 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.

As with the other call ratio backspreads the position gains in value as the price increases and is helped with an increase in implied volatility. Use a decline in the Implied Volatility Index Mean (IVXM) below 65 or no change in the stock price for 15 days as the SU (stop/unwind).

Best Calendar Spread – Takeover File

The Best Calendar Spread appears as a regular feature in the Rankers & Scanners section of our home page and in addition, this week it is also our newest addition to the Takeover File. Calendar Spreads are always problematic since in many cases the higher implied volatility is well justified by events underway making the near term options priced correctly.

Wyeth (WYE) 43.74. The Wall Street Journal online edition reports that Pfizer Inc. (PFE) 17.45 is close to an agreement to acquire Wyeth for between $65 and $70 billion in a cash and stock deal that would value WYE at about $50 per share. Further, the report said that they have been in talks for months and that a deal may not be agreed. With a Historical Volatility of 42 and an Implied Volatility Index Mean (IVXM) of 43.33, here are the details of Friday’s Best Calendar Spread using the closing mid prices.

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 1.275 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .02 for each point change in the stock price.

As an alternative here is another call ratio backspread suggestion that will benefit from rising implied volatility that is likely if this deal in not agreed quickly.

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 the same as the time decay is offset in the spread. Use the position net delta shown above to adjust for any stock price change or about .03 for each point change in the stock price.

As with the other call ratio backspreads, the position gains with a rising price and with rising implied volatility. Use a decline in the Implied Volatility Index Mean (IVXM) below 35 or no change in the stock price for 15 days as the SU (stop/unwind).

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".