Volatility Trading Digest - Strategy Suggestion
Volatility Trading Digest - Strategy Suggestion
Strategy
While watching the current correction develop over the last few weeks, we would like to say that the correction has run its course, but that would be contrary to the evidence. Until crude oil prices decline, we believe further advances in equities will be constrained and the risk is to the downside on any negative macro news event. In the meanwhile, we suggest additional hedging and we offer another VIX hedge below.
Hedge Suggestion
CBOE Volatility Index (VIX)
Since the pricing of the VIX options are from the futures and the April futures closed at 17 the most straight forward hedge is to buy the April 17 VIX call option. Accordingly, here is the hedge idea unencumbered with any attempt to use a spread or ratio strategy. Since the near term future contract is the most responsive the changes in the prices of the VIX here is the suggestion.
The April VIX futures expire on April 18 with the last day of trading on April 17. Use a close of the S&P 500 Index above the March 19 high of 1414 as the SU (stop/unwind).
As we mentioned in last week's Digest we booked all of the trade ideas using the closing prices on Monday and since two used weekly options, we closed them on Friday and marked the other two to market. In the order presented in the Digest Issue 12 last week, here are the updates and commentary.
Oracle Corporation (ORCL)
On Tuesday March 20 after the close, they reported 3Q net income of 2.5 billion, or .49 per share, compared with 2.12 billion, or .41 per share, for the year-earlier period. Revenue was 9.04 billion, up from 8.76 billion. Analysts were expecting .56 cents per share on revenue of 9 billion, while the whisper estimate was .57 per share.
After initially trading higher, the shares declined and closed off 1.19 for the week.
We booked the weekly March 23 straddle sale using the 30 strike prices for the sale of the put and call on last Monday's close for a 1.77 credit as the implied volatility climbed to 70.50. On Friday the 30 call expired worthless and the 30 put was 1.46 at the close. The net result on the implied volatility decline to 19.78 was a .31 gain.
Next the long hedge side of the suggestion, the April 30 straddle purchased at Monday's closing prices for 2.21 with implied volatility of 31.16. Friday's closing prices were 1.81 as the implied volatility declined to 20.15 for a loss of .40. The overall result before commission costs was loss of .09, certainly not worth the effort. The issue was the greater than expected decline in implied volatility for the long straddle part of the strategy.
Lululemon Athletica Inc. (LULU)
LULUposted better than expected 4Q results of .51 per share, up 34.2% from the prior period, compared to the consensus estimate of .49 per share, but less than the whisper estimate of .53 per share.
At the end of the week, the stock was up 3.84 on increased gross profit and an increase on comparable store sales.
Once again using the March 23 weeklies we booked the short 72.5 straddle on last Mondayís close for a credit of 4.92 with implied volatility at 83.13. Against this, we used a long April 72.5 straddle that was 7.85 on Mondayís close with implied volatility of 45.59.
On Friday, the March 23-72.5 calls were 3.45 with an implied volatility of 35.64 and the 72.5 put expired worthless. For this side of the strategy there was a 1.47 gain.
For the long April 72.5 straddle the Monday purchase was 7.85 with an implied volatility of 45.59. On Friday, it was 6.38 with an implied volatility of 35.78 for a loss of 1.47. This time the result was a breakeven trade before commission costs as decline in the implied volatility of the long straddle was again more than expected.
KB Home (KBH)
KBH reported Q1 earnings of -.59 on Friday while the consensus estimate was for a loss of .23 per share. In addition, they reported orders declined in three of their four regions. While some analysts are saying it was company specific we are not so sure and we will be closely watching the XHB to see if it can remain above its upward sloping trendline at 20. On a close below, we will be looking to close out our KBH position.
By the end of the week, the stock had declined 2.47.
On Monday's close, we booked the sale of the April 11 put for .58 with an implied volatility of 71.59 and on Friday, it closed at 1.09 with implied volatility of 56.27.
Our estimate that it would hold above the upward sloping trendline was wrong and now we need to consider some alternatives. Our original plan was to take the stock by assignment, in the event of a close below 11 on the April expiration. We also have some other alternatives to consider, such as closing the position and realize the .51 loss or roll out the put by buying back the 11 and selling the April 10 put for a .49 credit. While the roll out alternative is still on the table, we will wait until we see a pivot in the stock price and then select the correct put for the sale. Until then we still have the choice of receiving the stock by assignment and then sell calls according to the original plan.
McMoRan Exploration Company (MMR)
MMR closed the week .76 lower and the option implied volatilities we slightly lower.
We booked our long May 14/16 call spread with the short April 12 put on Monday for a .26 credit and on Friday it was a .51 debit for a mark-to-market loss of .25.
The company has not released the anticipated test results from Davy Jones so our planned event is still in the works. Our risk here is one of time but we have a short put to offset the loss of time value in the long May call spread, but our plans could change on a close below 12 on the April expiration. Stay tuned.
The suggestion above is 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
While there are some reasons to believe the correction in equities is over, we are not convinced until we see some weakness in crude oil prices that will help to support the transports. In the meanwhile, we continue to suggest more hedging strategies.
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