Volatility Trading Digest - Euro Indifference

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Volatility Trading Digest - Euro Indifference

Last Friday, with the financial markets waiting in nervous anticipation, the European leaders delivered a carefully crafted message from Brussels that they had reached an historic agreement to draft a new treaty intended to create closer economic integration in an effort to confront the sovereign debt crisis. In response, the markets seemed to have reacted with a yawn since it was not enough to excite either the bulls or the bears. Consequently, traders will most likely revert to considering the usual seasonal year-end trading strategies. After reviewing the most relevant of our market indicators, we offer another year-end volatility trade idea followed by another quarterly report suggestion.

Strategy

Trading strategies based upon macro fundamentals continue to be a challenge since the fundamentals remain uncertain and many of the technical indicators are equally indecisive. The outlook for the European economy is unknown and the market reaction the news on Friday reflects apathy. From a longer-term perspective, the euro looks to be near the middle of a trading range supporting the view that the fundamentals remain uncertain.
 

 
Now just below the range midpoint defined by the green lines at 1.20 and 1.50, it currently looks oversold with a potential small double bottom pattern, making a year-end rally a good possibility. If so, a somewhat stronger euro should translate into a weaker dollar helping to support equities, assuming "risk-on" continues to follow a lower dollar.
 
Seasonal Implied Volatility
Following up on the suggestion made last week, here is another seasonal volatility suggestion as a replacement for those who may have closed out last weeks' idea on Thursday with the VIX close above 30.

The seasonal tendency for equities to rise at the end of year is accompanied by a seasonal decline in implied volatility. With the 13.76% decline on Friday it looks like The VIX is headed lower.

CBOE Volatility Index (VIX)

Here is a calendar spread alternative for the expected continued decline in volatility. If volatility continues to decline then the spread between the futures should increase as the January futures will decline faster than the February futures.

The December futures expire on December 21, (not December 16) so this suggestion uses January and February options in an effort to capture the decline that should extend into late December and early January.

The options vital statistics are in the VIX Options section above.

Consider this spread.
 

 
Once again, use a close back above 30 as the SU (stop/unwind).
 
Quarterly Earnings Report
Here is another in our continuing series of earnings report ideas. 

Negative RIMM Sentiment Creates Upside Opportunity Before Earnings

Research In Motion Ltd. (RIMM)
It has been a very difficult year for Research In Motion, as products such as its PlayBook tablet have been very disappointing pushing the stock down by more than 75% in 2011. The BlackBerry maker is scheduled to report quarterly results on Dec. 15 after the bell. The consensus estimate is 1.21 per share, while the whisper number is 1.24 per share. While it is hard to imagine it could get any worse for RIM, many analysts believe there are still more headwinds ahead.

Citigroup analysts published a list of the top 10 reasons why things could get worse for the Canadian technology company. Some include the potential for delays in its QNX product launch initially scheduled for early calendar 2012 along with a decline in sales growth, which is expected to be less than half of the industryís smart phone growth rate.
The stock price has fluctuated between a 52-week high of 70.54 and 15.98 and is currently trading near the 52-week low. Resistance is near the December highs at 18.77, with support at 16.00.

The current Historical Volatility is 54.61 and 43.30 using the Parkinson's range method, with an Implied Volatility Index Mean of 72.50, down from 80.76 last week. The IV/HV ratio is 1.33 and 1.67 using the range method to calculate the HV. The put-call ratio is bearish at .88.

With so much negative sentiment, look for a surprise upward move after the report.
 

 
The December 19 calls were bid .15 each on Friday so the total for two is .30 shown above.

With only one trading day before the options expire, the position will need to be managed. There is risk it breaks below support at 15.98. In the unlikely event it closes below 14, be prepared to take the stock by assignment. In that event, the plan is to sell calls against the long stock position.

The prices for the VIX suggestion above are based upon last Friday's closing prices using the mid price between the bid and ask. The RIMM suggestion is based on the bid price for the sales and the offer price for the purchase. On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.

Summary
The market reaction to Fridays' news from Europe was hardly enthusiastic, insufficiently positive for the bulls; it was equally uninspiring for the bears. As a result, volatility should continue declining into early 2012.
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