Volatility Trading Digest - April Potpourri
Volatility Trading Digest - April Potpourri
Since we are going to cover a bit more territory than usual in this Digest, we will be omitting some of the option detail we normally include along with the trade suggestions. We begin with a strategy review along with an update for last Thursdays' tweet followed by an earnings report suggestion. Then we have two short ideas along with three more in the Takeover File. We begin with some strategy comments.
S&P 500 Index (SPX)
Last Tuesday's high of 1419.15 created a new upside resistance target. It is especially important since it needs to close above this level to negate the small Head & Shoulders pattern that is now a possibility.
On the downside, the first support is 1378.04 from February 29, which would also be below our upward sloping trendline that began with the November 28, 2011 low at 1169.29 and below the neckline of the small potential Head & Shoulders pattern mentioned above. Should it reach support at 1378.04, the trend will have changed. In the meanwhile, the VIX futures premium is back into normal territory. Here is the update.
S&P 500 Index Implied Volatility (IVXM)
Since last week, the Implied Volatility Index Mean increased from 12.84 to 13.35, while the CBOE Volatility Index (VIX) increased from 14.82 to 15.50.
The table below shows the VIX cash compared to the next two futures contracts as well as our calculation of Larry McMillan's day-weighted average between the first and second months.
The day weighting applies 60% to April and 40% to May resulting in the average premium of 2.18 or 14.06% shown above. Our alternative volume weighting between April and May results in a 13.44% premium. Both measures are back into the normal range.
In addition, open interest declined from 320,215 to 292,427, comparing Thursday to the previous week. By the end of the week, it appeared the VIX hedge was no longer going to be required so we have an update comment below.
While the VIX futures are implying a more positive outlook, we think there are three other things needed for the current uptrend to continue.
- The SPX needs to close above 1419.15, last Tuesday's high.
- Help from the transports, which have stalled due to the high price of crude oil and gasoline, which is possible since crude oil looks like it is starting to correct.
- A resolution to the NYSE advance-decline divergence by more issues advancing compared to those declining.
Last week we suggested a VIX futures hedge plan using the April 17 call option. Since the SPX closed higher last Monday and the VIX declined by .56 the plan was suspended. However, with Thursday's decline, as the April future increased to 18.80, we sent a tweet suggesting implementing the hedge using the April 19 call option. By the end of the week, the futures turned lower and the premium to the VIX cash declined, so we no longer suggest holding this option. While the VIX futures look as if they are turning higher, we will need to see the premium increase before suggesting another hedge idea.
High IV/HV Ratio Earnings Suggestion
Chipotle Mexican Grill, Inc. (CMG)
This fast-casual fresh Mexican restaurant chain is currently selling at 62 times 12 month trailing earnings and 39 times forward earrings with an estimated 2.22 price-to-earnings growth ratio. Scheduled to report 1Q earnings on April 19 after the close, the consensus estimate is 1.92 per share. The options implied volatility has been rising and it is likely to accelerate as the report date approaches. Ranked number one on Friday, it had an IV index mean of 28.99 and a 12.66 Historical Volatility for a ratio of 2.29.
The financial media and some analysts are beginning to wonder if the momentum has stalled so the uncertainty going into the earnings report is likely to increase. If so, the plan is to buy a straddle and sell it on April 19, after confirming they still plan to report earnings after the market close. Noteworthy, April 19 is one trading day before the April options expire. Although expensive in dollar terms here is the suggestion.
Close the straddle April 19. In the meanwhile, watch to see if it begins to sell off before the report date. If so a May put spread could also be considered before the earnings report.
United States Oil (USO)
If crude oil prices are going to continue declining, we have a ratio backspread to consider that will benefit from an increase in implied volatility as it declines. In addition, since the futures are in contango it costs to roll them into each next month.
The July 35 puts were .93 each with vegas of .0656 for the combined totals above. Use a close back above the 41 resistance as the SU (stop/unwind).
Sears Holdings Corporation (SHLD)
We last suggested a short strategy in January, just before a short squeeze began pushing the stock higher. Following our trade plan, we would have closed the put spread as the stock closed above 37.90 on January 19. Now we return after the stock closed below the upward sloping trendline from the January low along with signs that the short squeeze is over and news the company is liquidating more assets to meet is cash needs. It seems like a company in liquidation that is losing money should not be selling at 66 and certainly not at the recent the recent price of 85. Here is another ratio backspread idea since we think the implied volatility will increase as the stock continues to decline.
The June 55 puts were 3.68 each with vegas of .0936 for the combined totals above. Use a close back above the last pivot at 75 as the SU (stop/unwind).
View Ivolatility's post archive >