Volatility Trading Digest - Seasonal vs. Europe

---

Volatility Trading Digest - Seasonal vs. Europe

Without the negative sovereign debt news coming from Europe, equities would be responding positively to the normal seasonal strength that typically begins in November and runs through January. Now however, it looks as if there could be another test of the lows.

Strategy

S&P 500 Index (SPX)
Unfortunately for the bulls, the classical symmetrical triangle consolidation pattern we identified last week became an unusual reversal pattern rather than the higher probability continuation pattern we were expecting, as the European news once again overwhelmed the normal seasonal tendency. The break down below the consolidation triangle creates a new downside-measuring objective at 1163, which could become the missing right shoulder of a Head & Shoulders Bottom that we had been expecting in the later part of October.

The bulls will be further disappointed by the PowerShares QQQ (QQQ), closing below 56 and thereby setting off a Head & Shoulder Top with a measuring objective down at 53. This would seem to fit the same pattern as the S&P 500 Index.

On Friday, our day-weighted VIX futures premium was 1.62% compared to last week at .93%. The day weighting applied 88% to the December contract and 12% to January resulting in the average premium of .70 or 1.62%. 

For this short-term indicator the premium to the cash is a SPX sell signal suggesting professional expectations for the cash to increase toward the futures price. In the past, reversals have occurred when the readings were higher, both positive and negative.

While Thanksgiving week is usually marked by low volume and small price changes this year could be an exception since Europe will still be open all week grinding out more contentious news reports. As a result, our outlook for the near term has changed and we now think the chances have increased that there will be another downleg to at least 1163 for the S&P 500 Index. This could be followed by a rally into year-end after defining the right shoulder of the potential Head & Shoulders Bottom.

Jeffrey Hirsch at the Stock Trader's Almanac reports so far 2011 has been following a typical seasonal pattern and if it continues November, December and January will see higher stock prices.
 
We have an update for the earnings report trade idea we made last week for Salesforce.com (CRM)

On Thursday, they reported third quarter non-GAAP earnings of .34 along with a 36% increase in revenues after the close. The result was a two-day price decline of 13.9% that began during the day before the report was released.

Using last Monday's closing prices, booked the suggested one-sided iron condor consisting of the short 145/140 call spread and the short 110 put for a credit of 2.88.

With the stock price decline, the all of the options expired out-of-the money and we booked the 2.88 gain of 14.69%, based upon standard margin requirement of 1,940.
 
Quarterly Earnings Reports

Here is another noteworthy earnings report due this week.

Deere & Company (DE)
Primarily known as a farm equipment maker DE is scheduled to report on Wednesday before the opening. The consensus estimate is 1.44 per share with a whisper number of 1.46 per share. Consistent with recent quarterly reports we expect they will meet the estimate, but then provide cautious guidance and comments about the fourth quarter especially with the economic uncertainty emanating from Europe. For this reason, we suggest a put spread.
 
The current Historical Volatility is 39.17 and 31.12 using the Parkinson's range method, with an Implied Volatility Index Mean of 41.49, up from 37.46 last week. The IV/HV ratio is 1.06 and 1.33 using the range HV. The put-call ratio at .90 is in bearish territory, but could be due to hedging.
 

 
We suggest using a close back above the pivot at 78.52 as the SU (stop/unwind).

Here is another earnings idea a little further away.
 
Oracle (ORCL)30.60
Oracle, the benchmark for large US software companies, is scheduled to release its 2Q earnings on December 15 after the close. The consensus estimate is .55 per share. Many analysts believe this large cap technology company is undervalued, reflected by JP Morgan's price upgrade to 40 during the past week. 

Last week, Warren Buffet announced on CNBC that he had purchased a large stake in IBM, which initially boosted all of the software companies. Buffet believes in IBM specifically, but his investment thesis crosses over into companies like Oracle.

The main question for investors is whether this information has been priced into the market. Technically, ORCL has consolidated in a tight range between 34, with the 50-day moving average near 30. The current consolidation comes after a 25% upmove move from the lows near 25 in mid-August. 

The current Historical Volatility is 37.33 and 25.95 using the range method, with an Implied Volatility Index Mean of 38.95, up from 34.17 last week. The IV/HV ratio is 1.09 and 1.50 using the range method HV. The put-call ratio is a bearish 2.75, but understandable since put are being used for hedging going into the earnings report.

Use a put sale with a volatility advantage to finance an ORCL call spread.
 

Close or unwind the position if it closes below 29.
"

---

View Ivolatility's post archive >