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Thursday, July 18, 2013

VIX Futures 1st/3rd Month Spread Starting To Look Attractive

As of July 18, 2013 closing prices, the VIX Aug/Oct (1st/3rd) futures spread is trading 2.38.  That seems a bit high so I compared the current spread to historical levels.  The chart above shows the VIX Futures 1st/3rd month spread since October 2012 expiration.  Why since October 2012?  On September 6, 2012, ECB announced the Outright Monetary Transaction which helped to lower all back month VIX futures prices.  Prior to this announcement, VIX back month futures had been trading as high as 25-28 level--much higher than the long-term mean of VIX at around 21.  Currently, the VIX Feb 2014 futures are trading 20.10 and VIX Mar 2014 futures are trading 20.50, which are levels representing a "normal" VIX futures term-structure.  Therefore, comparing the current VIX futures term-structure with those of the past since September 2012 would be appropriate.

The above chart shows the median values of the VIX 1st/3rd month futures spread counting from 18 trading days to go before the expiration of the front month futures.  As you can see in the red line, the median (average) level of the spread during the period 18 trading days to 9 trading days is about 1.80-2.00.  Furthermore, I plotted the MAX values of the spread in blue and the MIN values of the spread in green.  Basically, with VIX 1st/3rd futures spread trading at 2.38, there is 0.43 "edge" to sell that spread (buy Aug VIX futures, sell Oct VIX futures for credit of 2.38 or higher).  Furthermore, August is an expiration month of VIX futures that is 24 trading days long, which means that there is an additional 1-week window where selling of the spread can work in your favor.

One would want to "sell" the VIX 1st/3rd month futures spread when one expects equity market volatility to rise.  The spread would narrow usually because the front month futures would rise a greater amount than the third month futures would rise.  Usually, VIX rises when the S&P500 Index declines.  On the flip side, if equity market volatility was expected to fall (usually when the S&P500 Index rises), one would want to "buy" the VIX 1st/3rd month futures spread.  Case in point, on June 21, 2013, when the S&P500 Index was falling, the VIX Jul/Sep month futures spread was trading as low as 0.35.  On July 16, 2013, which was the last day of trading for the VIX July futures, that spread had risen to 3.20!

In looking at the chart of SPY, there is currently nothing in the charts or indicators that would make one doubt that this bullishness in SPY would not continue.  However, both short-term and mid-term trend channels point to technical resistance at around the 170-171 level.  Furthermore, SPY has come up pretty far, pretty quick.  Even a 2% decline in SPY over the next 3 weeks could make VIX Aug/Oct futures spread fall to 1.95.

The pricing of the VIX Aug/Oct futures spread and the 3 week time period of window for even a mild correction in SPY makes selling of that spread a good risk/reward trade.

Monday, July 15, 2013

Is TEVA Finally Set to Rise?

eSignal chart w/custom indicators
LiveVolPro Chart
Teva Pharmaceutical Industries Ltd (ADR) or TEVA's ADR price has been in a long-term bearish trend.  After hitting 64.43 on March 22, 2010, TEVA's ADR price fell to 35.26 on September 23, 2011 and has basically moved sideways since then.  In light of soaring stock price of ACT--another pharmaceutical company that sells generic drugs, and even the sideways move of the Israeli stock market, TEVA's ADR has drastically underperformed.

Most recent trend points to a scenario where TEVA's ADR price is looking to break out.  Right now, it is testing it's trend line resistance.  Furthermore, volatility had fallen near to its low ranges, indicating that time is right for any fundamental news to be able to push the ADR with greater ease.

For example, on June 24, 2013, TEVA launched generic version of Viagra (sildenafil) in countries across Europe.  Furthermore, earnings are expected to be announced on August 1, 2013.  Perhaps, earnings report and conference call will shed some more light on  whether the new CEO and management team (who took over in May 2012) has taken substantive steps to improve the long-term business outlook of the company during their first year at the helm.

LiveVolPro screen capture
In terms of options activity, 10,000 September 42.5 calls were bought today for average price of 0.325.  Time & Sales data (provided by LiveVolPro) does not always show if the options were bought or sold.  However, considering that implied volatility of the Sep 42.5 calls rose today, we can conclude that the 10,000 contracts were bought.

September implied volatility of 19.5 still look reasonable given that price fluctuation of TEVA shares have averaged 20 vol over the past few months.

Volatility:  Consider going long Sep 20 straddle & scalp gamma.
Directional: Consider going long Sep 40 or Sep 42.5 calls or the Sep 40/42.5 call spread.

Wednesday, July 10, 2013

Tenet Healthcare Corp. (THC) Looks Vulnerable to Downside

eSignal Chart w/my custom indicators
 Tenet Healthcare Corp. (THC) stock price is looking vulnerable to the downside.

Technical Analysis:
1) lower peaks, lower troughs
2) RSI divergence most recent new high
3) Relative under performance of stock price vs SPY

Fundamental News Analysis:
1) 6/27/13:  Fitch Ratings Report states that hospital companies are experience systemic shifts in care delivery. Persistent weak trends in organic volume growth...

2) 6/24/13: THC agrees to acquire VHS for $4.3 billion including debt in a deal.  THC offer $21 a share, 70% premium over previous day's close of $12.37.

LiveVolPro Chart
3) 6/6/13 Deutsche Bank upgrades THC due to prospects for THC to acquire other hospital chains (previous close $44.37).  4/10/13: Deutsche Bank had downgraded THC (previous close $43.52)

4) 4/29/13:  THC moves sharply higher on a pair of upgrades from Baird & UBS (upgrade comes after 1Q earnings announcement, closing price $43.84)

So basically, current price of $43.17 is below the stock prices of days where most recent analyst upgrades came.  More significantly, THC has Long-Term Debt / Equity Ratio of 5.55 as of 1Q 2013 balance sheet compared to UHS Long-Term Debt / Equity Ratio of 1.29.  This is prior to THC announced takeover of VHS and plans to take on more debt.  The recent significant spike and uptrend in interest rates cannot be good for THC's financials moving forward.

Finally, the announced one-year delay in Obamacare's employer mandate is also seen as a blow to short-term stock price momentum.

In terms of options pricing, the Realized (30-day) Volatility Indicator has been declining and last value was 40.65.  However, for the past few months, realized volatility has averaged around 45.  The implied volatility of August 43 strike options stands at 43.5, so I would say August IV is slightly cheap, considering August is an earnings month.  THC announced its earnings report date to be August 6, 2013.

Volatility Strategy:  Buy August 43 straddle and scalp gamma into earnings.
Directional Strategy: Buy the Aug 43/39/37 broken-wing put butterfly for 1.03 mid-point value.

Tuesday, July 2, 2013

Introducing My Technical Analysis Framework For Options Trading.

I remember 10 years ago when I first entered the world of options market making.  Prior to that, I had traded equity index futures and had become pretty proficient with technical analysis.  I remember though instantly losing credibility upon mentioning "technical analysis" in options circles in those days.  I wonder if it is still the case...

Technical analysis, however, is much more than chart pattern reading.  Technical analysis is really THE physical means to perceive what is metaphysical--price, markets, volatility, greed, fear, etc.
In options trading, one must be aware of price behavior or speed and volatility, just as much as price direction.  What better way to do so than through a technical analysis framework that allows one to perceive any market in multiple dimensions.

The first chart lists all the indicators that go into my options trading framework.  The indicators are as follows:

1) Price Dimension
a.      candlestick price chart
b.      log scale in Y-axis
c.      trend lines, trend channels
d.      moving averages
e.      Relative Strength Index

2)      Time Dimension – Intraday, Daily, Weekly, Monthly.  Daily period chosen here.

3)      Volume Dimension – Volume at Price Indicator

4)      Volatility Dimension
a.      Trend/Range Gamma Indicator
b.      Implied Volatility Indicator for Gold futures (if available, in this case $GVX)
c.      Realized Volatility Indicator, my custom method to calculating 30-day historical volatility

5)      Correlation Dimension – Inter market Ratio (Gold to Silver)
 The trading rules are rules-of-thumb but are as follows:

1) Delta - Determine the trend, determine confidence of direction, and determine how much leverage through delta one would want to apply.

2) Gamma - If Trend/Range Gamma (TRG) Indicator crosses above its lower or upper Bollinger band lines or the moving average line, look to see if price breaks above or below a short-term resistance or support.  At this time one would look to be long gamma.  On the flip side, if TRG indicator crosses below its moving average line, one would look to be short gamma.  The confidence of leveraging gamma would be determined by choosing the appropriate expiration dates of options.

3) Vega - If realized volatility indicator and/or an implied volatility indicator are at low end of its 3-month, 6-month, or 1-year ranges AND are starting to rise, then look to be long vega.  On the flip side, if RV or IV is at high end of its 3, 6, 12-month ranges AND are starting to fall, then look to be short vega.  The confidence of leveraging vega would also be determined by relative value of implied volatility to realized volatility, as well as, implied volatility level differences between options with different expiration dates.  To determine this, one would need an effective indicator to calculate "fair value" of future expected volatility.

The second chart explains how all the indicators provide an aggregate picture and means to anticipate future price behavior.

The holy grail in trading (arguably) is not to predict the direction of price in the future but rather be able to determine whether prices would move in a trend or move within a range in the immediate future.  TREND or RANGE?  If we knew this, we could simply switch to and follow buy/sell signals from the appropriate indicators.
TREND or RANGE?  Options traders try to answer this question just as much as stock or futures traders, but in the options world, the language is "long or short gamma".  The third chart shows instances in the market where being long or short gamma using options would have been optimal (at least for gold or GLD).

So why not combine insights from both the directional trading and volatility trading worlds?  Yes, volatility trading may require a more quantitative approach, but I do not see one world as being "better" than the other.  For those traders that follow a more discretionary approach, volatility indicators would provide a way to perceive price along another dimension.  Is not greater awareness just perception through multiple dimensions?

I would highly appreciate feedback.  Is this technical analysis framework for options trading just a compilation of ubiquitous indicators?  Or an insightful methodology to trade options?

Additional content and research can be found in Technical Analysis on Volatility (My Conceptual Framework).