Volume 14 Issue 34
Relative Strength

According to S&P Capital IQ August has typically been a weak month for equities and until last week it appeared this year might also be a disappointment. While August is not quite over it now looks like it could be a record breaker as the S&P 500 Index (SPX) 1988.40 set a new closing high Thursday while the Powershares QQQ (QQQ) 99.05 broke out to close above the previous high every day last week demonstrating real relative strength. Only the iShares Russell 2000 (IWM) 115.21 remains stalled at lower levels. Rather than waiting for the small caps to catch up perhaps a better strategy is to go with relative strength.

Accordingly, in this issue we have a relative strength suggestion for Powershares QQQ (QQQ) followed by a new addition to the takeover file for AstraZeneca PLC (AZN) and then a look at the options market stance on the ongoing geopolitical situation in Ukraine with Market Vectors Russia ETF (RSX). First, a quick update on the important options indicators.

CBOE Volatility Index® (VIX) 11.47 down 1.58 for the week while the VIX futures premium closed in positive territory at 19.73 % and was in the double digit green range since Wednesday.

CBOE S&P 500 Skew Index (SKEW) 135.10 measures the purchase of out-of-the-money S&P 500 Index puts that require a very large downside move to profit from long put positions. An increase of this index indicates greater expectations for an extreme down move. The CBOE explains further, a Skew value of 100 means the perceived distribution of S&P 500 log-returns is normal so the probability of outlier returns is negligible. As Skew rises above 100, the left tail of the distribution acquires more weight increasing the probability of outlier returns.

In the past SKEW advanced as SPX approached a previous high. This week it declined .33 however, it remains in the upper part of its current range between the June 20 high at 143.26 and the recent August 8 low at 120.36 made just as SPX turned higher from the recent pullback.

Relative Strength

Powershares QQQ (QQQ) 99.05.

Last week in Digest Issue 33 “Flight to Safety” near 97.50, we commented QQQ had been relatively stronger than both SPX and IWM so any decline would have raised the possibility of double top. Since then, QQQ powered higher eliminating the double top possibility, but it now needs to retest the breakout above 97.50.

The current Historical Volatility is 11.21 and 8.95 using the Parkinson’s range method, with an Implied Volatility Index Mean of 11.23 down from 12.45 the week before. The 52-week high was 20.72 on April 11, 2014 while the low was 10.04 on July 3, 2014. The implied volatility/historical volatility ratio using the range method is 1.25 so option prices are about right relative to movement of the ETF. The put-call ratio at 1.30 is understandably bearish due to hedging long positions. Friday’s option volume was 353,092 contracts traded compared to the 5-day average volume of 370,620.

Consider this synthetic long or risk reversal idea that allows enough time for the likely breakout retest.

With narrow bid/ask spreads and good liquidity, the indicted net debit is .51, with a reasonable implied volatility spread between the long call and short put, while there is a consider spread between the historical volatility of the ETF at 8.95 and the short put at 14.33. The breakout above 97.50 made a well-defined place to establish the SU (stop/unwind) just in case. There is a good chance it will retest 97.50, but a close below will change the picture.

Takeover File

AstraZeneca PLC (AZN) 73.05 ranked number 3 in Friday’s high IV/HV category.

Since Pfizer made a run at AZN last April and then withdrew, speculation is growing they could make another offer perhaps soon, but some say later in the year is more likely.

The current Historical Volatility is 20.34 and 12.90 using the Parkinson’s range method, with an Implied Volatility Index Mean of 36.35 up from 28.83 the week before. The 52-week high was 43.78 on May 19, 2014 while the low was 11.39 on November 15, 2103. The implied volatility/historical volatility ratio using the range method is 2.82 so option prices are expensive relative to movement of the stock. The put-call ratio at .08 is very bullish. Friday’s option volume was 13,845 contracts traded compared to the 5-day average volume of 18,400.

Consider this long bull call spread.

The net debit of 1.52 is about right at 30% of the spread width, while the implied volatility could continue higher an October spread should be enough time to discover if Pfizer intends to renew takeover efforts. Use a close back below 70 as the SU (stop/unwind).

Options Perspective on Geopolitical Risk

Market Vectors Russia ETF (RSX) 24.91, is a market capitalization weighted float adjusted index comprised of traded companies domiciled or generate the majority of their revenue in Russia. Here is the price chart for the last year.

Next the options implied and historical volatility chart with option volume below.

As expected, the options implied volatility along with options volume spiked up in March to 52.20 as the ETF declined down to 21. Then the implied volatility declined down to 22 in early July before the latest developments that caused the ETF to sell down once again. This time it found support at 23 before rebounding above 25, but the implied volatility only advanced slightly compared to March.

The current Historical Volatility is 33.55 and 15.81 using the Parkinson’s range method, with an Implied Volatility Index Mean of 28.18 down from 31.60 the week before. The 52-week high was 52.20 on March 14, 2014 while the low was 18.00 on December 27, 2013. The implied volatility/historical volatility ratio using the range method is 1.78 so option prices are somewhat expensive relative to movement of the ETF. The put-call ratio at 2.05 is bearish, but used for hedging long positions. Friday’s option volume was 9,792 contracts traded compared to the 5-day average volume of 7,610.

Look at the at-the-money September options data.

The low options volume and open interest especially for the puts does not suggest much enthusiasm for hedging long positions and in conjunction with the recent ETF price rise from 23 suggests more interest on the long side. This is hardly a negative indication for this largest and most liquid Russia related ETF and not the stuff of panic selling.

While we are not suggesting positions in either direction, we do suggest the options market currently does not reflect expectations of further deterioration in the news from Ukraine.

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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Summary

While the S&P 500 Index is back into new high territory, the Powershares QQQ, representing the large capitalization NASDAQ stocks has broken out to the upside. Only the small capitalization Russell 2000 continues lagging the market. While geopolitical risk remains a concern options on the Russia index ETF are not reflecting a rush to take short positions or hedge longs.

Actionable Options™

We now offer daily trading ideas from our RT Options Scanner before the close in the News section of our home page based upon active calls and puts with increasing implied volatility and volume.