Volatility Trading Digest - Takeover File Update
Volatility Trading Digest - Takeover File Update
Yahoo! Inc. (YHOO)
YHOO is a digital media company in the process of reorganizing or perhaps being sold. The stock price is up on news that Jack Ma and others including Microsoft may be interested in the company as they explore the possibility of selling their interest in Yahoo Japan.
Better than expected earnings of .21 were reported on October 18 and the stock initially sold off, only to quickly recover.
For those who may be wondering why we are repeating this suggestion for the fourth time it is because it keeps coming up in our active call scan as one of the stocks with the highest call activity. Then on Saturday AP reports Google is exploring the possibility of helping to finance a possible deal by others to acquire the company according to a report published report by the Wall Street Journal.
The current Historical Volatility is 47.87 and 43.21 using the range method. The Implied Volatility Index Mean is 57.98, down from 70.44 last week, for an IV/HV ratio of 1.21, but 1.34 using the range method. The put-call ratio is extremely bullish at .27 as there were 3.75 times more calls traded than puts and there were 15 call strikes with more than 2,000 calls traded. Friday's volume was 236,563 contracts compared to the 5-day average of 262,250 contracts.
Here is another call spread combination updated for the higher prices, but otherwise similar to the ones suggested in the previous four Digest issues.
Use a close back below the last pivot at 13 as the SU (stop/unwind) or be prepared to take the stock by assignment in the event it closes below 15 on the November expiration. If so, then the plan is to sell calls against the stock position. If the November put expires out-of-the-money then sell the December 15 put and then once again in January reducing the call spread cost each time. If the stock gaps up on Monday due to the recent Google news then it may be necessary to adjust the spread strikes higher in order to obtain a ratio near 30%.
Here is another idea from one of our contributing authors that takes a somewhat different approach to high volatility trading.
High HV/IV Ratio
Morgan Stanley Volatility Looks Attractive Ahead of the EU Summit.
The binary nature of the capital markets has made it difficult to pick solid individual equities or commodities in the face of the EU summit on Sunday.
The EU has set a self-imposed date, to come up with a grand solution on how to deal with the peripheral countries debt and this headline risk in the past week has made directional trading very difficult.
The banking sector seems to have been most affected by the uncertainty as many banks have substantial exposure to European sovereign debt. In some European countries, restrictions have been implemented to disallow shorting of these stocks, which has spilled over into US financial institutions. If Europeans are unable to short their bank stocks, they can still short banks in the US markets.
Some US banks have been beaten down based on low earnings expectations, some of which were released during the past week. Investment banks, Morgan Stanley and Goldman Sachs both beat expectations after being reduced significantly earlier in the third quarter.
Since volatility is likely to remain high and premiums are significantly higher than their historical long-term averages, we want to find an opportunity with some protection against volatility, while maintaining the trade potential. One way is to use an instrument where movement of the underlying is greater than the implied option price.
When the 30-day historical volatility is greater than the implied volatility, there is an opportunity to make money by delta hedging the position as the market chops up and down.
Morgan Stanley (MS)
After reporting better than expected earnings of 1.14 last Wednesday, the implied volatility has declined in line with many of the other financial institutions. The current level near 64% is relatively high when compared to the longer-term moving average near 45%. Despite the relatively high IV the historically volatility of the stock is even higher, with the current 30-day historical volatility near 90%. This means a delta hedger could have earned back most of the premium during the past 30 days. The low implied volatility to historical volatility ratio makes MS an interesting long straddle candidate.
With MS is at the upper end of its recent trading range here is a delta neutral idea. Purchase a straddle using the November 17 strike, buying both the call and put. Using the offer prices quoted, the straddle settled at 2.41.
If MS breaks through the highs, look to delta hedge near 18. If it breaks down, buy shorts back near 14.75. If implied volatility breaks through the 55% level on the downside, stop out of the trade. Look to take profit on implied volatility near 80%.
All of the suggestions above are based upon last Friday's closing prices using the mid price between the bid and ask. On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
Summary
The combination of an uncertain outcome to the summit meetings in Europe along with a large number of earnings reports scheduled to be released this week is likely to keep volatility high as the S&P 500 Index tries to sustain its breakout from the recent trading range.
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