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1/22/12

Technical View: The S&P continue to grind higher last week and closed the week at 1,315, right near the 78.6% Fibonacci for the May 2011 highs to the 1,120 major support in August/September. The move above 1,270 still has yet to accomplish the measured move of 1,330, and a new trading range of 1,270 to 1,350 may emerge, similar to the range from March 2011 through late July when the market broke down. Although overbought on the daily with the S&P on its upper acceleration band, the weekly chart leaves room to 1,375 until the upper band is reached, and the weekly McClellan Oscillator is only at 65, plenty of juice left in this rally considering the dry powder on the sidelines with Hedge Funds very under-invested. The McClellan Oscillator on the daily is at 160, room to get more overbought with a 225-250 reading a likely sign of the end of the trend, making a pullback likely. RSI, MACD, and TRIX all remain in strong uptrends, providing credibility to the uptrend. As for resistance levels I am looking at 1,315, 1,330, 1,350 and 1,370 as the key levels. As for support, the rising 10 day EMA has provided support intraday, and a close below that would be the first sign to look for a 3 to 5% pullback, also eying a move in the RSI below 50 as a sell signal. Support levels heading into this week are 1,297, 1,282.50, and finally a re-test of 1,270 would be a level that would likely find buying support when the market does eventually correct. As for now, no need to call a top and fight such a strong uptrend, buy dips until a close below the 8 day EMA occurs.

Sentiment/Internals: The AAII Sentiment Survey continues to register an overly bullish sentiment, although looking back to 2010 this has little predictive value of a pullback as the bullish sentiment was 40% to 60% the entire rally. The CBOE Equity Put/Call Ratio dropped to 0.6 last week, the lowest reading since May 2011 and nearing a bullish extreme, and a similar situation with the Option Buyers Sentiment Gauge. However, the Institutional Paper continues to have a bullish bias, and many January positions were rolled out and up. The 21 Day Arms Index closed at 0.98, the most bullish reading in months, while the McClellan Summation Index also climbs to new heights. On Friday 255 New Highs and 51 New Lows, the strong ratio continues to be in favor of further upside. Currently 79.4% of stocks are trading above 50 day moving averages, while just 54% above 200 day moving averages. The VIX closed at its lowest level since July, and all signs point to a move back to the 15 level, while Treasuries are also starting to break, a sign that investor appetite for risk is improving as Europe stabilizes, China/India are staying strong, and the US economic data shows continuous signs of improvement. The "elephant in the room" is earnings as the number of positive surprises is running at its lowest rate since the height of the financial crisis, but still early in the season. Equity Funds inflows came in at +$3.3B, the second straight week of inflows, and a lot of room for more with record outflows in 2011. Short Interest has been driven to a 9 month low as well, so any further market upside needs to come from new buying, not short covering. The last time short interest was this low was March 2011 and the market peaked at 1,363.6 the following month. In conclusion, Sentiment is at a bullish extreme on most indicators, but contrarians have been run-over many times in the past trying to predict the top, so it is best to look for real signs of market weakness via price action, situations when markets stop rising on good news, and start falling on bad news. Currently, markets are shaking off bad news, and using any nugget of good news as an excuse to rally.

January 27th, 2012

Huntsman (HUN) call buyers back with 4,000 March $13 calls bought at $0.60, trading 2X daily calls with 87% offer side and IV jumping as chemical M&A heats up

Astex Pharma (ASTX) trading 2,125 of the February $2.50 calls, already 6,849 in OI, and IV30 jumping 16.5% today. The Biotech is also breaking out to multi-month highs. The $213.6M Biotech trades 1.7X cash value with no debt. On February 9th Astex is expected to hear from a FDA Panel for Dacogen for treatment of acute myelogneous leukemia with a March 6th PDUFA. Back on 12-30 February $2.50 calls were bought in size, and have been active the past week as well.

EnCana (ECA) now sees a bullish spread like we saw yesterday in various names, the April $16 puts sold 15,000X to buy 7,500 July $21/$23 call spreads, net $0.03 credit on the spread.

Banco Itau (ITUB) bull flag and trading 3X daily options volume with 2,960 June $22/$20 bull risk reversals, and 3,200 June $23/$19 bull reversals each trading today.

Manitowoc (MTW) breaking out and 2,500 March $15 calls opened at $0.50/$0.45, a name that has 21,181 in March $10 Open Interest, and reports 1/31

The Strategy: Short (Reverse) Iron Condor

Description: This strategy involves buying both an out-of-the-money vertical call spread and out-of-the-money vertical put spread. The distance between the strikes on the call spread and put spread should be equal, and the spread is always entered as a net debit in the same expiration month. This strategy is generally entered in an option chain expiring within one month. As a 4-legged spread the trader must take into account higher commission charges.

Directional Bias: This strategy does not have a directional bias, and the intent is to catch a sharp move in either direction.

Volatility Bias: This strategy is Vega positive, attempting to catch a volatile move in a stock that has perhaps consolidated into a tight trading range and is ready to breakout or breakdown.

Theta Impact: Decay is most evident during expiration month, but negligible for longer-dated strategies.

Strategy Advantages: The Reverse Condor typically has a narrower breakeven range compared to strangles and straddles, losses and potential profits are well defines, do not require margin, and require no directional view.

Strategy Disadvantages: High Cost of Commissions for 4-Legged Spread, Limited Profit Potential, Lower Reward/Risk Ratios to Other Complex Spreads.

Profit Potential: Limited; Max Profit = Vertical Spread Strike  Difference - Net Premium Paid; Trader Should Seek At Least a 1:1
Reward/Risk Ratio

Risk: Limited; Equal to the Net Debit of the Spread; The strategy fails if the stock remains in the tight trading range and does not move past the breakeven points.

Break-Even Points: 2 Points; Upper Breakeven = Strike Price of Long Call + Net Debit; Lower Breakeven - Strike Price of Long Put+ Net Debit

P/L View:

Market Conditions to Apply: A range-trading market with upcoming catalysts that could result in volatility expansion and sharp price moves for stocks. However, in this strategy it is more of a focus on the individual underlying asset rather than overall market conditions, but do favor a market that is seeing wild swings.

Screening for Candidates: This strategy is best applied to stocks that are set to make a strong move in either direction, and often are used ahead of a price catalyst such as Earnings, FDA Event, or other stock-moving events. The candidates will also have to have good liquidity in options with tight bid-ask spreads to avoid over-paying for the spread. A few criteria applicable for finding a Reverse Condor Spread candidate:
 Market Cap +$300M; Average Volume > 300,000; Price >$20; Optionable
 Stocks at Major Resistance/Support Level
 Battle-Ground Stocks - Stocks with Lofty Valuation, High Short Floats, etc.
 Tight Bollinger Bands, ATR Wilder (14) Below 3 Month Average
 Historical Volatility (HV30) 25th or Lower Percentile
 Earnings/Catalyst Upcoming

Managing the Trade: A few potential scenarios and ways to manage the spread:
 Stock Remains in Range in Early Part of Trade Timeframe, Volatility Comes Down --> Buy Back the Short Calls/Puts to Convert to Long Strangle
 Stock Makes Decisive Move to Upper Strike of Call Spread or Lower Strike of Put Spread --> Close Spread for Profit or Sell a Credit Spread and Convert to a Butterfly Spread on One Side
 Stock Moves Lower Below Put Spread Max Profit Level --> Close Put Spread and Long Call, Let Short Call Expire Worthless or Buy Stock Against Short Call
 Stock Moves Above Call Spread Max profit Level --> Close Call Spread and Long Put, Let Short Put Expire Worthless or Short Stock Against Short Put
 Hedging the Position with Stock to Lock in Gains and/or Adjusting Strikes via Rolls also Apply in Certain Situations

Putting It Into Practice:
Intuitive Surgical (ISRG) will report earnings 1/19/12 after the close, the day before January options expiration. The stock has averaged a 10% max move one earnings the past 4 quarters, which would be about a $45 move for shares that currently trade at $451.50. The $17.6B medical device Co. trades rich at 31.9X earnings, 1.87 PEG and 35.6X cash flow, but considered a top notch growth play in the industry, and loved by Institutions. After October earnings BofA raised its target to $400, Collins Stewart to $475, JP Morgan to $370 and Goldman to $412, so shares have exceeded most Analyst price targets.

The chart shows a rising wedge pattern with the 50 day SMA acting as support along the ride higher. There is a gap to fill at $390, right where the 200 day EMA comes into play, while the 200 day SMA at $382.75 is a likely target on a weak report, also a re-test of a longer term key level. Shares currently are re-testing the $450 breakout level, a move that measures to $490 on the upside, and likely see $500 on a strong report.

The Trade: Long the ISRG January $480/$500 Call Spread and $420/$400 Put Spread at Net Debit of $5.80 in a Reverse Condor

Reward/Risk: $14.20:$5.80
Profit Zone: Shares Above $485.80 or Below $414.20
 

1/20/12: Closed GOOG Butterfly Put Spread (Earnings Trade) +289%

1/18/12: Closed LVS Calls +70%

1/13/12: Closed HUN Calls +75.86%

1/9/12: Closed CMG Bear Call Spreads +42.3%

1/3/12: Closed MYL Calls +119%

12/13: Closed FDX Put Spreads +70.8%

12/9: Closed XLNX Puts +50%

12/5: Closed NWSA Calls +53.6%

12/5: Closed HAL Call Spreads +58.25%

12/5: Closed ORCL Calls +54.3%