Volume 14 Issue 22
Liquidity & Dividends

Not only did May end without the widely watched equity indexes selling off they even closed higher. The bears will say the inevitable sell off has just been postponed so expect it in June and indeed there is some historical evidence June, along with May is also weak month. For now, there is no evidence of weakness in the major large capitalization averages, representing stocks with good volume and liquidity along with reasonable dividends, but the same is not true for the lagging smaller capitalization issues. Eventually the continuing disparity will be resolved either by the big capitalization indexes declining, or by the laggards finding support and turning higher. Last week, until Friday the smaller laggards were attempting to turn higher.

In this issue we go with the flow by focusing on long ideas in this low volatility environment, first in the transportation sector with a Delta Air Lines Inc. (DAL) long call then an energy idea for Goodrich Petroleum Corp. (GDP). Next, an earnings calendar spread idea for Joy Global, Inc. (JOY) and another for The Interpublic Group of Companies, Inc. (IPG) and then finally T-Mobile US, Inc. (TMUS) in the Takeover file. First, we have brief comments on the ongoing disparity between the S&P 500 Index and the iShares Russell 2000.

S&P 500 Index (SPX) 1923.57 with four new closing highs above the previous May 14 high of 1902.17 the continuing advance on moderate volume surely emboldens the bulls while giving us a well defined support level to watch when it pulls back to retest the breakout above 1902.17.

iShares Russell 2000 (IWM) 112.86 the 1.21 point advance made on Friday May 23 took it above the well-defined three-point downward sloping trendline line from March 21 at 120.26 and set up the gap opening for Tuesday’s further 1.61 point advance. The gap in now a matter of concern since as a pattern gap it is likely to be filled especially since the “growth at any price stocks” turned lower again Friday. If the gap at 112.02 fails to act as support then the long June 111/115 call spread suggested in Digest Issue 20 “Tale of Two Markets” should be closed and attention focused again on 107.50, the potential neckline of a Head & Shoulders Top. Obviously, a decline below 107.50 would not be good for the equity market.

CBOE Volatility Index® (VIX) 11.40 last week VIX remained low closing just .04 above the 52 week low made May 23 at 11.36 while many individual issues also made 52 week volatility lows making it more difficult to find advantageous volatility trading ideas.

iShares Dow Jones Transportation Average Index (IYT) 145.31 continuing higher it now appears more overbought than last week. However, the rails and airlines remain strong and the transports are one of the most economically sensitive groups typically strong in the early expansion phase of sector rotation so a long position in this group seems reasonable. Due to low option volume, liquidity is too low for IYT the ETF, so here is an alternative for this important sector.

Delta Air Lines Inc. (DAL) 39.91 now in a well defined, but rather steep upward sloping trendline from the April 15 correction low of 30.54 it appears headed higher after breaking out above 38.75.

The current Historical Volatility is 25.23 and 24.78 using the Parkinson’s range method, with an Implied Volatility Index Mean of 28.25, up from 26.01 the week before. The 52-week high was 47.18 on July 17, 2013 while the low at 26.01 the week before on May 23. The implied volatility/historical volatility ratio using the range method is 1.14 so the option prices are not expensive relative to movement of the stock but are still near the low of the 52 week range. The put-call ratio at .70 is just bullish while Friday’s volume was 19,424 contracts traded compared to the 5-day average volume of 35,920 contracts, so options liquidity in the normal expiration months appears adequate.

Here is a long call to consider.

Use a close back below the breakout support at 38.75 as the S (stop).

Implied Volatility Change

Goodrich Petroleum Corp. (GDP) 29.00, an exploration and development company with 400K acres the Tuscaloosa Marine Shale in Louisiana, almost entirely oil with economics similar to the Bakken.

On Wednesday May 28, we sent a tweet notice about increasing implied volatility after it advanced 2.06 the previous day while the implied volatility index mean increased to 104.37, up 18.12 points as the stock advanced 2.06 to 27.40. Perhaps it was news released Wednesday about multiple presentations scheduled over the next three weeks in New York, Toronto, London, New Orleans, Houston and Chicago that caused the price and implied volatility advances the day before. Regardless, they seem anxious to tell their story.

The current Historical Volatility is 45.62 and 52.57 using the Parkinson’s range method, with an Implied Volatility Index Mean of 86.33 up from 86.25 the week before. The 52-week high was 113.58 on February 19, 2014 while the low was 54.37 on June 19, 2013. The implied volatility/historical volatility ratio using the range method is 1.64 so the option prices are still expensive relative to movement of the stock but down from the level reached last Wednesday are still near the upper part of the 52 week range. The put-call ratio at .27 is bullish while Friday’s volume was 8,046 contracts traded compared to the 5-day average volume of 23,840 contracts. The bid/ask spreads are wide so be careful. Here is a combination idea conditioned upon the ability to improve the bid/ask on the July call spread.

With good volatility edge in the June 25 put the bid/ask spread for the July call spread indicates a net cost of .85 compared to the middle price shown above at .63 (2.08-1.45). Unless narrowed from .85 to around .75 we suggest just using the short June put. Use a close back below 25 as the SU (stop/unwind).

Best Calendar Spread

Here is an earnings report calendar spread to consider from Friday’s “The Best Calendar Spread” a regular feature in the Rankers & Scanners section of our home page.

Joy Global, Inc. (JOY) 57.15 scheduled to report 2Q earnings Thursday before the opening with a consensus estimate of .70 per share the stock has been declining for more than two weeks. If it follows the same pattern as last quarter, it will rebound after reporting.

Here is Friday’s suggestion slightly modified to reduce the negative delta.

Ideally, a 20 point implied volatility differential between the higher priced June call, in implied volatility terms, and the lower priced October call is better. This time it is 18.35 and substituting October 60 call for the originally suggested October 57.50 reduces the cost and the net delta. We will have the answer Thursday.

High IV/HV Ratio

Even when implied volatility is low as measured by the VIX, there are still some good volatility opportunities available found by using our ranker and scanner tools. Here is another.

The Interpublic Group of Companies, Inc. (IPG) 19.12 scheduled to report 2Q earnings July 22 recent analysts reports suggest it will be much better than expected so the stock has been trending higher having just broken out above 18 and comfortably above the upward sloping trendline that begins on April 15 at the 16.14 low.

The current Historical Volatility is 16.56 and 19.18 using the Parkinson’s range method, with an Implied Volatility Index Mean of 40.24, up from 28.73 just the week before. The implied volatility/historical volatility ratio using the range method is 2.10 so the option prices are expensive relative to movement of the stock and near the upper part of the 52 week range.

Here is risk reversal idea based on the premise the uptrend continues. Since the report date is two days after the July options expire the plan is to unwind or close it on or before the last trading day for the July options.

Use a close below support at 18 as the SU (stop/unwind).

Takeover File

Having been in the news for months here is a takeover that is seeing renewed interest.

T-Mobile US, Inc. (TMUS) 34.33. Deutsche Telekom AG the owner of two-thirds of T-Mobile US has agreed to a plan by Japanese mobile company Softbank Corp to buy T-Mobile US Inc. and merge it with Sprint, the third-largest carrier. However, the U.S. Federal Communications Commission and the U.S. Justice Department have raised concerns the merger could lead to higher consumer prices and this could take a long time to be resolved.

Since a decision is not expected soon, implied volatility is likely to remain high providing opportunities to sell some option premium.

The current Historical Volatility is 34.69 and 26.03 using the Parkinson’s range method, with an Implied Volatility Index Mean of 43.85 up from 36.57 the week before. The implied volatility/historical volatility ratio using the range method is 1.68 so the option prices are expensive relative to movement of the stock and near the upper part of the 52 week range. Friday’s option volume was 24,306 contracts traded compared to the 5-day average volume of 11,890 contracts.

Consider this put sale.

In the event of an adverse FCC or Justice Department ruling, be prepared to take the stock by assignment if it closes below 32 on the June expiration, but a ruling seems unlikely before the June options expire.

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

May is over, the large capitalization stocks closed higher but the divergence with small capitalization stocks has yet to be resolved and while it appeared “growth at any price stocks” were rebounding they declined again Friday. Ultimately, the divergence will be resolved either by the big capitalization liquid stocks paying dividends declining, or by the small capitalization stocks finding support. For now, liquidity preference seems more important than growth. In the meanwhile, option prices generally are inexpensive so long calls or puts used for hedging remain favorable.

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.