Friday, January 27, 2017  1:16:20 AM

Volatility Leak

by Jim Brown

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Review prior updates here: 2014  2015  2016  2017  2018 
The market has a serious volatility leak with the VIX at record lows.

Investors are so complacent it is reaching a danger level. The VIX closed at 10.63 and very close to record lows. You have to go back to June of 2014 for a lower recent close at 10.28. Before that, you have to travel back in time to Feb-2007 for a close at 10.05. The next lowest close was 9.48 in Dec-1993.

With the VIX near 24-year lows, the market is at high risk of a sudden decline. You know the old saying, "When the VIX is high it is time to buy, when the VIX is low it is time to go." You cannot get much lower than we were today.

There is almost no premium on any index or security. This would be a great time to be buying puts because nobody expects the market to go down.

We are almost at the middle of the Q4 earnings cycle and February premiums are miniscule. With more than half of tradable stocks reporting earnings over the next three weeks, it is hard to find any positions with March options.

Companies that have already reported and spiked are setting the market up for a crash. It is as though the market makers know it is not going higher because the call premiums are very small, as in $1.25 for March calls almost in the money. It is crazy.

The market moves on Tue/Wed were mostly short covering. The indexes spiked up at the open and then went sideways the rest of the day. There was no follow through. Today the Dow was positive but the +32 point close was the same 32 points it gained when it gapped open. The Dow only traded in a 58-point range.

The S&P traded in only a 6-point range and posted lower highs all day. A break back below 2,295 could trigger some profit taking traders that could morph into stronger selling next week.

With multiple Nasdaq big cap stocks reporting after the bell including MSFT, INTC, GOOGL, PYPL, SBUX, JNPR, etc, only one of those stocks traded up in afterhours and that was Microsoft. That should put a negative spin on the Nasdaq for Friday but the Nasdaq futures have reversed a decent afterhours decline and are now positive. Why is that?

The small cap Russell failed to really participate in the early week rally. There was a rebound on short covering from a 6-week low but the index never reached the resistance highs. The Russell was negative today almost from the opening bell. Small cap stocks were up very strongly post election and they have not really consolidated all those gains. This could be a clue for direction over the next couple weeks.

While I understand the sentiment behind the market rally, I am amazed to see many stocks with gains like the DD/BA charts above. There are hundreds of charts like those and "normally" they are not sustainable.

I do not want to be a wet blanket here but we need to continue to be on guard for a market reversal. We know from experience that the market can remain irrational in either direction far longer than most traders can remain liquid if they are betting against it. I can list paragraphs of facts why we are due for a pause but what I believe may not be what the market believes.

I am going to be very cautious over the next couple weeks in recommending positions. Readers can pick extras out of the additional play graphic but there is not a lot to choose from because of the earnings and low premiums.

Jim Brown

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Current Portfolio

The fourth column in the portfolio graphic is the earnings date. We will always exit a position before that date unless specifically mentioned otherwise in the play description.

Lines in blue were previously closed.

Current positions

Covered Calls

January Position Recap

January was a tough month for writing directional premium. There was no direction. Stocks that had performed well in Nov/Dec experienced some short term volatility. For instance ACIA fell -$8 in one day and immediately recovered to trade higher. That cost us $147 on the stop. Netflix fell -$6 in two days to stop us out on Dec 30th before the stock went on to make new highs. Tesla fell -19 points in three days to give us a big loss but we reloaded the position and recovered the loss. The January cycle was a fight because of the individual stock volatility.

The January expiration was the last cycle for the Cash Machine portion of the newsletter. With the market moving sideways six of the last seven months we were forced to sell closer to the money than what was prudent and that meant closer stop losses. Being forced to write spreads on indexes/ETFs to meet the stated description of the Option Writer game plan caused me a lot of grief and I terminated this section with the January cycle. I will still do spreads on indexes/ETFs in the regular Option Writer section but only when it makes sense to do it. The market does not conform to our wishes just because we are on a calendar cycle.

Current Option Writer Position Changes

XBI - Biotech ETF (Put Spread)

The shoot from the lip comments from President Trump on drug prices plus the crash in Bristol Myers caused the XBI to reverse course and we were stopped out of the short side on the 23rd. The long put has little chance of developing any value unless there is another headline that knocks the entire sector sharply lower. In retrospect, the stop loss was probably too tight but we know how fast the XBI can move when headlines appear. Better safe than sorry.

Closed Feb $56 short put, entry .97, exit .43, +.53 gain.
Retain Feb $49 put, entry .25, currently zero.

New Option Writer Recommendations

GS - Goldman Sachs (Put Spread)

Goldman was the market leader in November with an unbelievable surge. Shares were flat for five weeks in Dec/Jan before crashing back -$16 over a three day period. A bottom formed at $230 and shares are moving higher again. There is strong resistance at $246 but as long as the market continues to make new highs, Goldman should be making new highs as well.

Earnings Apr 19th.

Sell short Mar $220 put, currently $1.94, stop loss $229
Buy long Mar $200 put, currently .48, no stop loss.
Net credit $1.46

Other Potential Plays (Spreads, Covered Calls, Naked Puts)

These are not official plays but a good place to start if you are looking for something else to trade.

February expiration is the 20th, March is the 17th.

New Covered Call Recommendations

No Covered Calls

Existing Option Writer Positions (Alpha by Symbol)

THESE ARE NOT CURRENT RECOMMENDATIONS. These are prior recommendations that are still active in the portfolio. Do NOT act on the plays described in this section. This is the archive of prior recommendations in the current portfolio.

ACIA - Acacia Communications (January Put Spread)

The Nasdaq decline in late November pushed ACIA down to $64.50 where the stock came to a dead stop. That is slightly higher than the $62.65 low in early November. I believe that is going tobe strong support if we should get another bout of market weakness.

Earnings Feb 9th.

Sell short Jan $60 put, currently $1.75, stop loss $66.85
Buy long Jan $50 put, currently .55, no stop loss.
Net credit $1.20.

ANET - Arista Networks (January Naked Put)

Arista has blasted off after they solved their import problems. The stock exploded past $90 and should continue higher.

Earnings Jan 31st.

Sell short Jan $85 put, currently $1.10, stop loss $89.85

CYTR - CytRx Corp (Covered Call)

It is going to be very hard to lose money on this position. It is possible but not likely.

CytRx is a biopharmaceutical research and development company specializing in cancer drugs. They will be presenting three abstracts this weekend at the ASCO cancer conference. Shares have been jumping around between $2 and $3.50 since March. With the conference this weekend the options are high.

Buy-write CYTR July $3 call, currently $2.93-$1.00. No stop loss.

CytRx received some bad news on a drug trial and the stock gapped down to 65 cents. We are waiting for some positive news to inflate the stock and we will sell a new call.

FDX - FedEx (Naked Put)

FedEx Corp posted lower than expected earnings in mid December and $13 decline in the share price. Support formed at $186 and $188 and shares should continue to rebound in a positive market. From all reports they had a good Q4 and probably did better than UPS.

Earnings March 21st.

Sell short Feb $180 put, currently $1.57, stop loss $185.50

INCY - Incyte Corp (January Call Spread)

Shares of INCY have been trending higher but they have a strongly repetitious pattern of peaks and valleys over the last year. The current spike has stalled and we should see another valley appear. Shares have hit a strong resistance range from $100-$118 and further gains could be difficult without some profit taking.

Earnings Jan 31st.

Sell short Jan $120 call, currently $2.00, stop loss $112.25
Buy long Jan $140 call, currently .90, no stop loss.
Net credit $1.10.

MELI - Mercadolibre (Short Put)

MELI is the largest online retailer in Latin America and they closed at a four-week high on Wednesday. They were recently upgraded by Goldman to buy with a $170 price target. Holiday shopping was probably good for MELI.

Earnings Feb 23rd.

Sell short Feb $150 put, currently $2.00, stop loss $155.50

NFLX - Netflix (January Put Spread)

Netflix surged after getting an upgrade from Evercore ISI saying expected competition had not appeared and they now had a lead in original content that was insurmountable. Shares should retest resistance at $130.

Earnings Jan 16th.

Sell short Jan $110 put, currently $2.00, stop loss $115.85
Buy long Jan $100 put, currently .70, no stop loss.
Net credit $1.30.

PANW - Palo Alto Networks (Put Spread)

PANW crashed after earnings in November from $165 to $123. After several weeks building a base at that level the stock finally found a friend that surprised everyone. Short seller Citron Research went bullish on PANW on the 5th with a $170 price target. Citron said PANW could have 85% of the Fortune 100 as customers by 2020. More than 60% of their revenue is now recurring subscriptions. Shares popped $11 over the last week on the upgrade. Citron said Bernstein had a report out on them last week that was equally as bullish.

Earnings Feb 20th.

If you are worried about the stop loss being too close, you could buy a January $130 put instead of the stop loss. The put is 40 cents today. If the stock is going to crash it will probably be before the January expiration.

Sell short Feb $130 put, currently $2.05, stop loss $132.75
Buy long Feb $120 put, currently .65, no stop loss.
Net credit $1.40

SIG - Signet Jewelers (January Naked Put)

The fourth quarter is normally the best quarter of the year for jewelers and Signet is moving to a 7 month high. Support at $90 in early December was decent and the stock is accelerating higher.

Earnings Feb 21st.

Sell short Jan $85 put, currently $1.40, stop loss $90.45.

SPY - S&P-500 ETF (Call Spread)

All the signs are pointing to an end of year drop in the markets and the potential for an ugly January until after the inauguration. I believe the market has peaked for at least the next four weeks. If the new president is sworn in without a mishap or terror event, the market should rally strongly out of the January decline.

This is a February strike because there was no premium in January.

Sell short Feb $230 call, currently $1.41, stop loss $227.65
Buy long Feb $235 call, currently $0.42, no stop loss.
Net credit 99 cents.

TSLA - Tesla Inc (January Put Spread)

Tesla has completed the acquisition of SolarCity and all that uncertainty is now behind them. Shares have been trending higher since the vote on the 17th. The $180-$185 level has been support in the past.

Earnings Jan 25th.

Sell short Jan $170 put, currently $2.70, stop loss $183.50
Buy long Jan $150 put, currently $.98, no stop loss.
Net credit $1.72.

WDC - Western Digital (January Naked Put)

WDC finally found some traction in the last couple of weeks and analysts continue to upgrade their estimates. Now that the SanDisk acquisition is well behind them and new products are hitting the market, they are the number one disk drive maker in the market.

Earnings Jan 26th.

sell short Jan $55 put, currently $1.06, stop loss $58.65.

XBI - Biotech ETF

The biotech sector has been in sell mode since mid November and hit a 7-week low last week. Today there was a 4% rally in Biotech Index and a 5% rally in the XBI. There was a double test of support at $59 over the last two weeks. While there is no way to predict what the market/sector is going to do over the next three weeks the first two days of 2017 have been bullish. I am recommending a put spread on the XBI. Since the sector has already sold off, it could see bargain hunting buying on any market decline.

Sell short Feb $56 put, currently $1.01, stop loss $58.85
Buy long Feb $49 put, currently .26, no stop loss.
Net credit 75 cents.

Margin Requirements:

There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.

Here is the most common margin calculation for naked puts.

100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))

For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)

Prices Quoted in Newsletter

At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.

The prices quoted in the newsletter are the end of day prices in most cases.

When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.

For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time the readers are able to get a better fill than the opening print because of market maker bias at the open.

For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.

All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.