30 Nov 2011 – 4 min Wai Yee Chen, head of derivatives at RBS Morgans, discusses her two-part Telstra trade strategy for a profitable investment.
TLS at $3.18
Week ended 25 November 2011 with XJO sitting at 3984
As the XJO lost 4.6% last week and broke below the 4000 mark, it gave the options market a lot of impetus. Weekly options volume over-took equities volume, which was less of a common occurence. Last week, as equities volume rose by 8%, options volume had a 72% increase. Examining the pattern between options and equities volume 5 weeks ago, would tell us a story about last week’s volume.
Five weeks ago, at the end of October, as the market closed the week 5% higher at a last recent high of 4353 on the XJO, in that week, options volume (just like last week) over-took equities volume. In the last week of October as weekly equities volume rose 8% (just like last week), options volume was higher by 52% for the week. What’s significant since end of October is that the market has since lost more than 8%. That spike in options volume was the peak of the market then.
With this similar pattern we saw last week, that is, weekly options volume taking over equities volume by a large percentage, could this be a signal of another pivotal point for the market? This time, reversing up?
Another interesting observation is the XVI.
From end October to last Friday, the CBOE VIX index has climbed from a reading of 24.53 to 34.37 on Friday. That’s a 40% increase in VIX with a corresponding 10% drop in the S&P500.
The XJO, however, has lost 8.5% in the same period, but its XVI has only risen from 24.78 at the end of October to 26.94 since last Friday. That’s less than a 10% jump. Comparing the XVI with the VIX, the XVI is much less volatile and more benign.
Another point of observation is that, in the last 5 weeks, the last time the XJO plunged to 4171 on 3 Nov and bounced off from there, XVI was at the depth of 31. Last week, as the market punched through the 4171 level and went even lower to under 4000, XVI was still at around 27.
This is telling me that the fear factor in the market this time around is less severe than when it was threatening to break the higher level of 4171 3 weeks ago!
Could these all be signs of a market turning around (to go up)?
Early this week (21/11/11), I wrote on the Finance News Network blog that NCM was pressured from a high of $35.65. Today (Thursday), NCM touched a low of $33.52 and is trading above $34, some 90c reversal during the day.
The message for me is: Time to buy on weakness today.
NCM fell to a low of $33.52 in the morning is now down only 33c at $34.17
Chance to go long on NCM and earn an income at the same time.
Dec expiry is on 22 Dec, only 28 days to go.
Sell option for some Christmas income!
Sell 20 NCM Dec11 $33.82 put for 85c
This is an income generation strategy.
But need to be able to purchase stock at $33.82 (though breakeven is $32.94).
Potential exposure is $67,640 for 20 contracts.
The XJO has fallen some 68 points this morning to 4190 due to the fear of the European contagion effect.
Is there further downside? Possible. Our chartist thinks the 4131 level as a key support level for the XJO, which if it does not hold, then we could be seeing 3850.
On the other hand, the US has been producing some progressively good economic numbers, which can see the market higher, once, the grey cloud from Europe clears somewhat.
What’s the best way to play this market?
For today, get some short term protection in, so you could enjoy your weekend and not worry about the Europeans for a few days.
Buy the 19Jan11 XJO 4050 put for about $1 or $1000 per contract.
If you were to spend $5k on this trade and if XJO falls to 4075 (which is possible), then you would be gaining about $1800 from this trade.
Short term protection. Exit if that eventuate early next week.
Following my post on the Aussie retailers on 19 Sep below, they had had very strong recovery.
19 Sep: “What’s interesting though, was end of August and early September when the XJO was trying to break above the 4300; where it closed at 4396 and 4307 respectively. On those 2 days, trading in call options on those three names, MYR, HVN and DJS, increased.
This action is suggesting to me that these retailers are some of the names that the market is using as leverage to a recovery in the market.”
As of last Friday 4 November, some strong put options on DJS were traded on Friday.
With DJS having put in more than 30% in the last 6 weeks from late Sep (rallied from $2.64 to $3.52), this had been very stong performance in the short term. Though this is not unique to DJS as most retail stocks had good rallies in that period, even MYR for example returned 24% in the same period, but options actions in DJS is suggesting profit taking is setting in.
On Friday, the large quantities of puts traded appeared to be closing of bullish put spread of $3.20 and $2.80 strikes, indicating that some are locking good profits on the retailers.
Time to lock in profits in retailers.
The last time we saw AWC had a good rally was early Oct where it rose in a few days from $1.30ish to $1.65 and call options during those few days were heavily traded.
On Friday last week, 4 November 2011, we saw relatively large quantity of calls went through on AWC again, almost 3 times the day before and about twice the daily average for the week (14,000 contracts vs daily average of about 7,000). However, despite the high call volume on Friday, on a weekly basis, its overall volume is still lower than the week before.
As AWC rose 5.3% on Friday 4 Nov 11, the question is, is this a repeat of its early October pattern, strong rise in a few days?
Well, putting its call actions in perspective of its historical pattern, the long call trading in AWC on Friday seems to lack conviction. Its likely that it will either fall below $1.50 and try for the $1.65 again or struggle along the way to get there. More likely former. I would wait for the former scenario to go long.