Volume 14 Issue 26
Actionable Options & More

If selling in May and June is the best the bears can do considering both the negative January affect and midterm election years are the most dangerous of the four-year presidential cycle when equity indexes usually peak in the spring, what will they be able to do in July and August?

After a brief review of our mostly positive market indicators, we offer a new idea in the bubbling hot oil patch for Kodiak Oil & Gas Corp. (KOG) from our friends at The Blue Collar Investor.

Then we look back at last week’s Actionable Options ideas along with Friday’s regular Top 5 ranker results to discover new trading suggestions for Dish Network Corp. (DISH) and Melco Crown Entertainment Limited (MPEL).

S&P 500 Index (SPX) 1960.96 while it is usually precarious to declare optimism when the index is so far above its upward sloping trendline now at 1862.88 Tuesday’s low volume key reversal got no respect and had little affect thereby demonstrating a lack of selling enthusiasm.

CBOE Volatility Index® (VIX) 11.26 was slightly higher than last week at 10.85 but still near the February 23, 2007 low at 10.58. The volume weighted VIX futures was comfortably in the green zone at 15.16%, down slightly compared to the previous week at 22.39%. However, the VIX put call ratio advanced somewhat from last week’s abnormal low reading of .12 to .21 indicating less VIX call option activity relative to puts although the July VIX at-the-money call implied volatility advanced to 74.65 from 65.65. In addition, the CBOE S&P 500 Skew Index (SKEW) 135.36 declined from 143.26 last week meaning out-of-money put buying declined.

Last week Digest Issue 25 “Inflation Jitters” presented the Consumer Discretionary Select Sector SPDR ETF (XLY) /Consumer Staples Select Sector SPDR ETF (XLP) index chart showing an index value of 1.461 and declining indicating discretionary stocks were relatively weaker. Adding to last week’s positive developments the index turned higher closing at 1.495 as the discretionary group advanced relative to the staples suggesting more risk taking despite high crude oil prices.

This is a short holiday week so expect both volume and volatility to decline.

Another Covered Call Writing Idea for Consideration

Over the past few months, we have presented many basic principles needed to master generating monthly cash flow by selling covered call options. Moving forward we will be presenting a series of “ideas for consideration” to demonstrate how this strategy can enhance portfolios. This week, the focus is Kodiak Oil & Gas Corp (NYSE:KOG). The prices are based on published options data mid-day on Friday June 27, 2014.

This company, in the “Energy” industry sector is ranked in the top 20th percentile of all industries with a beta (historical volatility) of 1.52. In addition to great fundamentals, the price chart is a thing of beauty.

Currently trading @ $14.34 (mid-day Friday June 27, 2014), the options chain shows the regular July 19 expiration 14 call at .70 – .85, with the 15 call at .35 – .40.

Checking potential returns for the $14 in-the-money and $15 out-of-the-money strike prices using the Ellman Calculator (Free copy available on the Blue Collar Web Site- free resources link on top black bar) we see:

Potential 3-week returns of between 2.4% and 2.6% annualize to between 41% and 44%. The $14 strike gives us 2.4% protection of that 2.6% initial profit and the $15 strike gives us 4.6% upside potential for a possible 3-week return of 7%.

One of the keys to successful covered call writing is to only select stocks that you would otherwise want to own in your portfolio and then select an appropriate strike price that meets your monthly goal. For maximum returns, positions must be managed in accordance with the trade plan. For example, we always buy back the option if the premium value decreases to 20% of the original sale in the first half of the contract term and 10% or less in the latter part of the term.

In the event it turns lower here is the exit strategy.

— KOG drops in price to $13.50 in the 3rd week of the contract but remains near its 20-day exponential moving average.
— $15 call value drops to $0.05 approximating our 10% guideline.
— Buy back the $15 call and wait a few days to see if share price recovers.
— Let’s say it recovers to $14 and the $15 strike is $0.30.
— Sell the same strike option in the same month for a net credit of $0.30 – $0.05 = $0.25 or $25 per contract.
— This will give us a net options credit of $60 per contract ($35 + $25) or 4.2% for the 3-week obligation.
— The final results will be dictated by share price @ expiration.
— If by mid-contract share value is stagnant, roll down to $14 call to generate additional cash and downside protection.
— If share price declines below $13, close the entire position and use the cash to enter a new covered call position to help mitigate losses.
— The BCI methodology also has exit strategies for situations when share price rises dramatically providing opportunities to generate even higher returns.

Mastering exit strategy execution and much more information on becoming an elite covered call writer, go to The Blue Collar Investor.

Actionable Options Review

Looking back at the Actionable Options ideas for last week, a regular daily feature found in the News section on our home page before the close based upon active calls and puts with increasing implied volatility and volume using our RT Options Scanner, we note mixed results. Of most interest, are the ones reported to have increasing put implied volatility and volume and then subsequently advanced in price within a few days. Examples include JetBlue Airways Corporation (JBLU), NorthStar Realty Finance Corp. (NRF), Gannett Co., Inc. (GCI). Although none reported earnings during the week there was active hedging.

Some declined in price as expected after appearing in the put category such as Accenture plc (ACN) after reporting earnings.

Then for those with increasing call implied volatility and volume, we see Nike, Inc. (NKE) signaled twice, once Wednesday and then again Thursday before the positive earnings report and Friday’s gap up opening.

Of course often the calls and puts are active on the same day as prices change but if the calls are active on a large decline it could signal support buying such as Dollar General Corporation (DG) on Friday.

While active calls or puts may not necessarily indicate the stock price direction, Actionable Options is a good place to find trading ideas for stocks currently in focus.

Broadcast Media Excitement

The long anticipated Supreme Court ruling in the Aereo matter generated excitement last week when the court ruled 6-3 against Aereo declaring their broadcasts, using tiny antennas over the Internet, violates copyright law.

Immediately share prices of the major broadcasters advanced while their options implied volatility declined.

However, there is one noteworthy exception not necessarily categorized as a content provider, but a distributor.

Dish Network Corp. (DISH) 65.64 broke out above 64 closing up 1.88 Friday placing it number three in our high IV/HV group, number one at the top of the 52-week range and number two for advancing implied volatility.

The advancing implied volatility suggests there is more to the stock price advance than just the Aereo ruling since the implied volatility of the broadcasters declined.

Included in the takeover section of Digest Issue 24 “All About M& A Activity” is where we think it currently belongs.

First the options data,

The current Historical Volatility is 20.78 and 21.48 using the Parkinson’s range method, with an Implied Volatility Index Mean of 50.68 up from 43.19 the week before. The 52-week high was 52.06 on May 2, 2014 while the low was 27.55 on March 21, 2014. The implied volatility/historical volatility ratio using the range method is 2.35 so the option prices are expensive relative to movement of the stock. The put-call ratio at .25 is bullish, but is somewhat distorted by a large August 80 call July volume at 2,054 contracts while July put volume was greater than the call volume. Friday’s total volume of 12,425 contracts traded compares to the 5-day average volume of 10, 740.

For now, we suggest the put side for long theta is the place to be so here is another suggestion to go with the one made in Digest Issue 24 “All About M& A Activity.”

Using the ask price for the July 57.5 call at .60 and the bid for the 62.5 call at 1.50 shows a credit of .90. Using a put spread reduces the margin requirement to 500 so the projected return of 90 would be 18% in 22 days and part will be a holiday week. Since the bid/ask spreads are wide it may be possible to improve the credit somewhat, perhaps by as much as .20 increasing to 1.10 boosting the return up to 22%.

Here is another idea, number five from Friday’s high 52-week range scan.

Melco Crown Entertainment Limited (MPEL) 35.26 declining since March it now appears to be making a bottom along with others in the casino group as analysts start issuing upgrades.

The current Historical Volatility is 42.75 and 32.57 using the Parkinson’s range method, with an Implied Volatility Index Mean of 45.87 down from 48.00. The 52-week high was 52.24 on May 7, 2014 while the low was 31.28 on August 16, 2013. The implied volatility/historical volatility ratio using the range method is 1.41 so the option prices are somewhat expensive relative to movement of the stock while the put-call ratio at .10 is bullish. Friday’s volume at a whopping 133,859 contracts traded far exceeds the 5-day average volume of 29,980.

Still high but now declining implied volatility confirms a possible trend change.

Consider this put sale.

Use a close below the last pivot at 32.63, which would also be back below the downward sloping trendline as the stop level.

Except where indicated, the suggestions above use the closing middle prices between the Friday bid and ask, Monday option prices will be somewhat different due to the time decay over the weekend and any price change.

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Summary

Signs of professional hedging noted in last week’s Digest by the low VIX put call ratio improved somewhat last week suggesting less hedging enthusiasm along with other indicators are also better and mostly positive including better relative consumer discretionary performance although crude oil prices remain elevated. Since this is a holiday week, expect to see low volume and declining implied volatility.

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.