Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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As a part of a brief market review, we look at recent activity in the crude oil futures market and then offer some ideas based upon the premise the recent crude oil price decline is ending. First Anadarko Petroleum Corporation (APC), followed by SeaDrill Limited (SDRL) Halliburton Company (HAL) and finally Goodrich Petroleum Corp. (GDP).
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S&P 500 Index (SPX) 1931.59 the decline began Friday July 25 when a potential symmetrical continuation pattern underway disappointed may have ended Friday with the 22.02 advance. However, the advance could also have been more about short covering before the weekend in the event positive geopolitical news could change sentiment. iShares Russell 2000 (IWM) 112.27 the relative strength seen early in the weak was probably due to a combination of selling large capitalization stocks with European exposure and rotation trading since IWM was oversold and due for a bounce. Keep in mind the potential double top, activated on a close below the neckline at 108, with a measuring objective at 95. If so, the relative strength could be an opportunity to establish a short position anticipating it will eventually close below the neckline and then accelerate to the downside. Therefore, stay focused on IWM this week for signs of weakness relative to the S&P 500 Index. CBOE Volatility Index® (VIX) 15.77 down 1.26 for the week while the VIX futures premium managed to close in positive territory at 1.83% after being negative all week. However, 1.83% is still in the lower part of the yellow caution zone. Crude Oil WTI (CL) 97.57 basis September futures, in Digest Issue 30 “4 Rotation Challenge Ideas” we noted the declining open interest suggested the previous uptrend was ending as existing longs liquidated to existing shorts who begin covering. At the top on June 24 Large Speculators we long 458,969 contracts based on the Commitment of Traders report and by August 5, the most recent report they were down to 347,204 contracts after declining for six weeks. On the other side the Commercials have been reducing their short positions and then the August 5 report shows open interest advanced 9,499 contracts suggesting the Commercials may be gaining the upper hand as they continued to reduce their next short position by 7,468 contracts. On Thursday, the September contract turned higher. Seasonally August is usually a weak month, but both 2012 and 2013 were not as weak as prior years. September and October are typically stronger as prices rise into year-end. Based upon the rapid reduction in the net short position of Commercial Traders the crude oil price decline may be ending. Geopolitical concerns pushed the US dollar higher to the detriment of crude oil so any easing of tension should support crude oil prices. While keeping in mind it could still be too early here are some oil patch ideas to consider. Anadarko Petroleum Corporation (APC) 109.23 in at number five for Friday’s implied volatility advance, up 2.83 or 8.61% to 35.68 the price gained 2.11 points. Advancing implied volatility along with advancing price suggests an opportunity especially when there is good options volume. The current Historical Volatility is 29.20 and 22.62 using the Parkinson’s range method, with an Implied Volatility Index Mean of 35.68 up from 31.39 the week before. The 52-week high was 37.14 on July 29, 2014 with the last earnings report while the low was 19.68 on May 23, 2014. The implied volatility/historical volatility ratio using the range method is 1.58 so option prices are high relative to movement of the stock. The put-call ratio at .15 was very bullish while Friday’s option volume was 23,984 contracts traded compared to the 5-day average volume of 14,430. Consider this put credit spread idea.
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Using the ask price for the buy side and mid for the sell, the credit would be .85 representing a 17% return on investment based upon a margin maintenance requirement of 500 assuming APC closes above 100 at the September expiration. Use a close back below support at 105 as the SU (stop/unwind). |
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SeaDrill Limited (SDRL) 36.70 although more controversial due to the almost 11% dividend rate, the options implied volatility is lower than Anadarko. The stock advanced .98 Friday on news the new West Saturn ultra-deep water drill ship had been contracted to ExxonMobil for two years at 706K per day considerably more than recent analysts comments suggested was the current market day rate. The current Historical Volatility is 24.27 and 16.55 using the Parkinson’s range method, with an Implied Volatility Index Mean of 25.22 up from 24.83 the week before. The 52-week high was 28.73 on February 20, 2014 while the low was 17.58 on May 18, 2014. The implied volatility/historical volatility ratio using the range method is 1.52 so the option prices are high relative to movement of the stock. The put-call ratio at 1.75 is bearish reflecting considerable hedging activity in front of the 2Q earning report due August 27 before the market open. Friday’s option volume was 9,204 contracts traded compared to the 5-day average volume of 6,160. Consider this short put idea before the earnings report, but at a reasonable distance below the current price.
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Use a close back below the most recent pivot at 35 as the SU (stop/unwind) or be prepared to take the stock by assignment and earn a 12% divided in the event it closes below 34 at the September expiration. Halliburton Company (HAL) 68.31 after recently breaking the upward sloping trendline despite a positive earnings report on July 21 followed by multiple upgrades this is a trend continuation candidate in the event crude oil prices stabilized and begin to turn higher. The current Historical Volatility is 23.63 and 19.47 using the Parkinson’s range method, with an Implied Volatility Index Mean of 24.13 up from 23.89 the week before. The 52-week high was 31.62 on October 9, 2013 while the low was 18.88 on July 22, 2014 the day after reporting earnings. The implied volatility/historical volatility ratio using the range method is 1.24 so the option prices are reasonable relative to movement of the stock. The put-call ratio at 1.10 is bearish reflecting hedging activity. Friday’s option volume was 19,623 contracts traded compared to the 5-day average volume of 24,680. Since there is no earnings report due in the near future, look at this synthetic long idea assuming the uptrend will resume in the near future.
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Using the ask price for the buy side and mid for the sell, the debit would be 1.11. Use a close back below the most recent pivot at 66.77 as the SU (stop/unwind). Goodrich Petroleum Corp. (GDP) 19.93 originally suggested in Digest Issue 22 “Liquidity & Dividends” it has been trending lower after reporting Tuscaloosa Marine Shale drilling results that disappointed. Then on the most recent August 7 earnings report, that included updated drilling results, it gapped up making a well-defined pivot to use for a trading plan. With attractive implied volatility that also implies significant price risk, consider this synthetic long suggestion. The current Historical Volatility is 61.77 and 50.19 using the Parkinson’s range method, with an Implied Volatility Index Mean of 73.32 down from 78.75 the week before. The 52-week high was 113.58 on February 19, 2014 while the low was 60.31 on June 6, 2014. The implied volatility/historical volatility ratio using the range method is 1.46 so the option prices are high relative to movement of the stock. The put-call ratio at .10 is very bullish while Friday’s option volume was 8,562 contracts traded compared to the 5-day average volume of 13,360. Consider this synthetic long idea with a short put offsetting time decay of the long call.
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Using the ask price for the buy side and mid for the sell, the debit would be .72. With a reasonable volatility edge, use a close back below the most recent pivot and gap at 17 as the SU (stop/unwind). The suggestions above use the closing ask prices for the buys and middle prices for the sells presuming some price improvement from indicted prices is possible for liquid stocks. Monday’s option prices will be somewhat different due to the time decay over the weekend and any price change.
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In next week’s issue, we will review all our market indicators with special emphasis on crude oil |
Finding Previous Issues and Our Reader Response Request |
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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. Another way to find them is the Table of Contents link in the blog section of our website.
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 us to look at a specific stock, ETF or futures contract, 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. |
Portfolio risk reduction evidenced by US dollar strength relative to the euro has taken a toll on both equities and crude oil for the last two weeks. While it may be premature to declare the pullback is over, there are a few positive signs worthy of attention. While many were focused on the bond market decline after the + 4% 2Q GDP report released July 30, the more important action was risk reduction in response to the deteriorating situation in Ukraine.
