Watch those IVs on BHP and RIO

Last Friday close (20 Jan 2012) for BHP of $37.48, FMG $5.19, RIO $67.53

 

Huge volume in trading of BHP, FMG and RIO last Friday, in decreasing order. Of interest is the Implied Volatility (IV) of these 3 stocks which were at very low levels, even lower than the last low reached on the 5 Dec 2011 when those stocks hit resistance and reversed down from there. On 5 Dec, BHP was at early $37 and RIO was $67 before reversing down. As IV has an inverse relationship with its underlying stock price, it’s timely to watch these two for an impending turning down from here.

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Implied volatility and share price

There is a comment on my Covered call Options strategy on TLS on Jan 8 by impliedvolatility on 19 Jan (thank you! Great to get some feedback for discussions)

Copied here so we can all learn more about this topic.

Impliedvolatility says:

Wai-Yee uses a well considered analysis to support her recommendation to for TLS share holders to write some out-of-the-money calls against their stock. She puts the case that the recent runup in TLS price will run out of steam as we have entered the 45 day before ex-dividend date and the stock is at 18 month highs – a good setup for a covered call.

I disagree with her interpretation of the implied volatility. It is normal for stocks that are showing strength to display falling implied (and often historical volatility) – this can be seen from the 12 month chart of TLS share price and implied volatility below. It also shows the recent building of implied volatility as TLS approaches its half year earnings announcement on 9 February 2012. Perhaps the best time to write covered calls is just before the earnings date when IV often peaks to extreme values, before being crushed the following day after earnings have been released – refer to earnings announcement dates in February 2011 and August 2011 in the same chart below.
The seasonal Implied Volatility chart for TLS shows how IV often pops prior to earnings in February and August and then declines once the earnings announcement has been digested by the earnings public.
 
Tls

My comments:

I have done a comparison chart on the TLS and TLSIV and you are absolutely right with the spike in IV in early Feb and Aug just before results.  It’s likely that IV will spike again in early Feb. 
 

But what’s key is what would the share price be at that time? As options premium are made up of intrinsic value AND  time value AND volatility,  in order to capture the highest possible call premium for a writer/seller share price need to stay high. Looking back at the  IV spike last year on 2 Feb and 9 Aug TLS was at around $2.80. Often, at the $2.80 level on the share price, it renders the writing of call option uneconomical  (though we get a  spike on IV). Also, with the spike in early Feb, the likely expiry to write on at that time would be Mar.

The strategy here captures a Feb expiry, with around 3.5c call premium and if IV tanks after reporting in early Feb, it will be even more ideal for the Feb call to expire worthless, earning dividend and extra call premium in February.

To recap, the best scenario for investors to write calls would be an IV spike + a high share price eg $3.40 on TLS share price.  But time erosion plays a part in how much is available when those conditions happen and if they do.  Indeed, the 3 components play a major part in options premium – IV, Share price, time value.

Let’s review in early Feb to see if those conditions present themselves for those who have not covered their TLS shares.

XVI (Aussie VIX) is under 20. What’s the implication?

Last Friday (13 Jan 2012), the XJO closed near 4200 with the XVI at 19.

What does a low XVI mean?

One and a half weeks ago on 4 Jan, when XJO was at a similar level(near 4200), the XVI was at a higher level of 23 . This  time, as we are hitting the 4200 level for the second time in less than 2 weeks, the XVI is only at 19. The lower XVI is indicating a more optimistic investor mood (less fear). The XVI generally have an inverse relationship with the performance of the XJO.

Is 19 low for XVI?

From previous times, each time the XVI falls below 20, it normally doesn’t stop there. It normally falls further before picking back up. The depth varies, but generally at least dropping to around 17, if not the lower of about 15 or 13. So, at 19, it may not have finished falling (which means more potential upside on XJO!)

The last time the XVI was at 19 was in early Dec. 2011 Again XVI didn’t pick back up from there (19) until it fell all the way down to 13. The XJO hit a high of early 4300 at that round. This time at 19, this indicator is telling me that it may continue to fall lower in the teens with more potential upside to go on the XJO (perhaps 4300 like in early Dec11).

What about volume?

The supportive news is that trading volume in Index (XJO) options has increased in the last week. Though the traded volume in both calls and puts were equal last week, but this is a strong move on the calls. This is because it is quite common for trading in puts to be higher than calls in most weeks due to portfolio protection strategies. Last week though, the increase in calls traded were twice as much as the puts (not common at all)

The last time we saw this sort of  strong volume in the calls  was a month ago. This may sound familiar but again it was early Dec 2011 when the XJO pushed all the way up to 4300.

The volume in the XJO calls is adding to the hypothesis that the XJO has a good chance of rising to the 4300 level in the short term.

Getting a boost from the banks

Getting a Boost From the Banks – CNBC

http://www.cnbc.com/id/15840232/?video=3000066328&play=1
Tuesday, 10 January 2012 2:10 PM ET Wai Yee Chen, Head of Derivatives at RBS Morgans discusses why options are a good way to make some extra income if you are dependent on dividends
Banks are expected to be neutral, trade in a range. They face macro-challenge (European debt crisis raises wholesale funding cost) and domestic issues (recovery in property values to boost mortgage lending, increase in business lending and consumer spending). In those 3 key areas, NAB has led in market share towards the end of 2011.
However, next five months is going to be a dry spell for NAB, it has just paid dividend, In order to justify holding on to the share, we need to make it work harder.
Options Strategy: Sell Strangles
Simultaneous selling of puts (lower strike) and calls (higher strike) with share price in the middle of the two strikes for 2 lots of income.
Feb $24.51 call and Fe $22.51 put gave 82c credit.

ATAA Sydney MONDAY 16TH JANUARY 2012 5.30pm

SYDNEY

Monday, 16th January 2012 at 5:15pm

Venue:

The Auditorium, Level 1, The Bowlers Club at 99 On York, 95 York Street, Sydney.

6.00 pm: Welcome by Tahir Omeri


5.15 pm: Refreshments and Visitor Registration


6.00 pm: Welcome by Tahir Omeri


6.05 pm: Wai-Yee Chen – Flight or Fight

In her presentation entitled Flight or Fight, Wai-Yee shares how investors can manage fear with practical survival tips for the current market.

Wai-Yee
 is an investment and options adviser and educator and is the author of OptionsWise:How To Invest Sensibly. Wai-Yee has been advising investors since 1996, and her strategies and views are sought after by Sky Business Channel and CNBC through regular interviews and invitations to speak at seminars and conferences. Wai-Yee writes regularly for TraderPlus, Your Trading Edge and other investment magazines and blogs. She is currently a Partner and Derivatives Specialist with RBS Morgans, Macquarie Street, Sydney.

6.45 pm: Meeting Break


6.55 pm: Colin Nicholson reviews The Luck Factor by Dr Richard Wiseman


7:00 Wai-Yee Chen continues


7.55 pm: Book Raffles

– Trend Trading by Daryl Guppy
Kindly donated by John Wiley & Sons Australia
– The Psychology of Persuasion by Dr Robert B Cialdini
Kindly donated by Colin Nicholson

8.00 pm: Closing announcements by Tahir Omeri

8:15 pm: Depart for dinner

La Bora Italian Restaurant, 9 Barrack Street (one block from meeting venue).

Further Information:
Tahir Omeri 0402 964 627 or Raymond Khoury 0403 619 053 or Colin Nicholson (02) 9439 9724.
Next meeting:
Monday, 27th February 2012. Note: 4th Monday in February
Next speaker:
 Sinan Koray – Position Trading on Forex Markets
Future meetings:
Usually the 3rd Monday of each month

Options Strategy for Telstra

TLS.ASX closed at $3.33 on 6 June 2012. This is a 18 month high for TLS. Stock is expected to go ex-dividend in third week of February.

How can shareholders take advantage of TLS’ strength and earn even more income from it with the use of options strategy?

Before going into the strategy, let’s look at some of the drivers/motivators (or lack of) for the stock in the next 2 months:

1 One of the driver which had been pushing up TLS is its upcoming dividend which is expected  towards 3rd week of February. The impetus for this motivator would not be there from the 2nd week of January, as the 45 day holding period of the stock has lapsed. This 45 day holding period is important for those who intend to buy the stock for the dividend and franking credit, with the objective of selling the stock on the first day it goes ex dividend. Holding less than 45 days will render shareholders foregoing the franking credit. This 45-day motivated buying will cease from week beginning 9 Jan 2012.

2 Next is TLS’s share price. It has reached close to a 18 month  high above the $3.40 level last week.

3 The third factor about TLS is very important. This is the divergence between the rising share price and falling Implied Volatility (IV) on the stock. This divergence at the moment is stark. The gap/gulf between the two is very wide, ie share price at the top and its IV at the bottom. A similar divergence is seen back in Dec 2009 when TLS was sitting at the then peak of around $3.50 whilst its IV was also at its then bottom range. At the peak then, the IV was at around high of 17, before dropping to early 13 and then rising from there as the stock price came off from the $3.50 top.

Now this time around, we have seen TLS’s IV dropping to a very low reading of mid 11 before Christmas. Since then, the IV has been climbing. As of Friday (6 Jan 2012) it’s IV was at early 18. What about TLS’ share price? It hit a high of $3.42 last week Tuesday.  With the IV climbing from its low and the share price at this high level, it is suggesting to me TLS has hit a peak and is more likely to come off from this level.

4 Last component is options actions on TLS. There are large quantities of calls opened in the first three months of the year. The two largest opened strikes (apart from LEPO) are the $3.20 for both Feb and Jan 2012.

Putting the above together, it’s time to write covered calls on TLS, locking in some premium in addition to the upcoming dividend would serve its shareholders well with enhanced income.

The 23Feb12 $3.21 Calls last traded at 3.5c on Friday. Writing this European call will ensure one’s shares don’t get called away before dividend, whislt earning an extra 3.5c.