Volume 14 Issue 36
Two Upcoming Event Ideas

This week we have two ideas for upcoming events that are dominating the news while saving the important European Central Bank announcement made Thursday for next week’s market review.

When options implied volatility rises before an expected event, it signals expectations that the price of the underlying will likely change, perhaps significantly. While not a foolproof indicator, the record of large moves exceeds those times when the underlying price change is small. Knowing the event date is helpful when selecting the options expiration date and planning a strategy, one that could even include some extra leverage.

This week we have two event ideas, the first is GT Advanced Technologies Inc. (GTAT), related to the new product announcements from Apple Inc, (AAPL) on Tuesday and the second is Yahoo! Inc. (YHOO) related to the upcoming Alibaba Group Holding (BABA) IPO. First, a few market observations.

S&P 500 Index (SPX) 2007.71 although the close set another record high it made a lower intraday high and lower low than the previous day. Normally this implies the short-term trend is down, but it closed on the high and the low at 1990.10 could be considered a successful a retest of the breakout above the July 24 high at 1991.39. Since the volume increased, it suggests a successful breakout retest so unless sidetracked by geopolitical interference it looks to continue higher.

iShares Russell 2000 (IWM) 116.38 following, but underperforming the brief pullback in the SPX, it remains well below the July 1 high of 120.97 needed to breakout out above the current range thereby establishing a new uptrend. In the meanwhile, a potential double remains the operative technical pattern. Even though the dollar continues higher, small capitalization domestic stocks, are not responding and continue lagging the large capitalization indexes.

Powershares QQQ (QQQ) 99.89 following the same pattern as the SPX it also made a lower intraday high and lower low closing at the high for the day while the intraday low at 99.03 is considerably above the previous July 24 high at 97.51, which would be consistent with its relative strength.

CBOE Volatility Index® (VIX) 12.09 up .11 for the week while the VIX futures premium at 12.56% was above 10% every day except Thursday when it closed at 9.99% putting it in the green all last week.

Event Ideas

GT Advanced Technologies Inc. (GTAT) 16.99.

Since Apple invested $700 million into GTAT to open facilities for producing screens made of scratch resistant sapphire, expectations are high for sapphire screens in both the iPhones and the iWatch when Apple announces new products Tuesday September 9. However since analysts are divided on both the current valuation and future prospects for the company the options implied volatility is high relative to the movement of the underlying stock making it number 5 on Fridays high IV/HV scan and number 3 for advancing IV, up 9.58 or 11.82%

The current Historical Volatility is 50.75 and 43.94 using the Parkinson’s range method, with an Implied Volatility Index Mean of 90.62 up from 79.29 the week before. The 52-week high was 104.59 on November 4, 2013 while the low was 53.80 on May 23, 2014. The implied volatility/historical volatility ratio using the range method is 2.06 so option prices are high relative to movement of the stock. The put-call ratio at 1.10 is understandably cautious due to hedging long positions. Friday’s option volume was 59,206 contracts traded compared to the 5-day average volume of 45,660.

One alternative is to fade the high implied volatility by selling both sides and risking a loss on a large move of the underlying. Another strategy is the opposite by assuming the high-implied volatility is right and the underlying will make a significant move. However since we don’t know the direction this suggestion is long the both the call and put sides. First a long call spread.

Then a long put spread.

Using the ask price for the buy and middle for the sell the call spread is a .30 debit while the put side is .37 for a combined debit of .67 representing 34% of the width between the strikes on both sides in the event of a significant price move. In the event the price move is less than expected, declining implied volatility will make it a loser, but limited by the short and long legs on both sides. The plan is to close it shortly after the Apple new product announcement on Tuesday.

Yahoo! Inc. (YHOO) 39.59 with a 24% stake in Alibaba Group Holding (BABA) with a reported IPO scheduled for September 18, it has been trending higher since the July 18 low of 32.93 along with increasing implied volatility. On Friday, it ranked number 2 in the high IV/HV ratio category.

Presuming September 18 is correct with the first day of trading September 19, the regular September options that expire on the same day are just right.

Since both the price and implied volatility are likely to continue advancing into the IPO date it seems like a ratio backspread with an extra long call should do well.

The current Historical Volatility is 19.68 and 17.37 using the Parkinson’s range method, with an Implied Volatility Index Mean of 49.27 up from 48.52 the week before. The 52-week high was 49.41 on September 2, 2014 while the low was 26.94 on July 22, 2014. The implied volatility/historical volatility ratio using the range method is 2.83 so option prices are quite expensive relative to movement of the stock. The put-call ratio at .39 is very bullish with Friday’s option volume at a whopping 395,462 contracts compared to the 5-day average volume of 219,490.

Here is the ratio backspread idea.

With good options liquidity, using the ask price for the buy side and middle for the sell the debit is .09. The long vega from the extra long call gives it an implied volatility edge. The plan is to sell it the day before the Alibaba IPO so be aware of any delay announcement that could require changing the option expiration dates.

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 again closed in new high territory, it also looks as if it may have successfully retested the breakout. The Powershares QQQ, representing the large capitalization NASDAQ stocks may have also retested the breakout while maintaining relative strength compared to the S&P 500 Index. Although the US dollar is trending higher, the small capitalization iShares Russell 2000 continues lagging. Unless upset buy an unforeseen geopolitical event it looks as if the major large capitalization indexes will continue higher. In the meanwhile, scheduled specific company events offer some interesting trading ideas.

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.