Stocks Highlighted With the market more stable to start the day, my focus will be on two names that have been trending. I expect these names to continue their trends after breaking out yesterday. With the prevalence of automated trading and trend following systems in the market, we often see that those stocks that have rallied continue to do so and those that have been weak continue to fall. I expect WTW and P to continue their trends and will walk through possible trades in each name. WTW Weight Watchers International Inc Technical Chart To start, we will look through the equity chart for WTW to see what we think the market should do next: There are a few important notes from this chart. First, we can see a very clear uptrend over the last 3 months. WTW has had two consecutive strong earnings reports, and as a result, there does not appear to be a strong case for the fundamental bear here at this time he will need some piece of new information to justify that case. On the technical front, WTW has been consolidating in a tight range for a couple of weeks and yesterday broke out to the upside. There was a particularly powerful break out as the stock had broken lows of the prior couple of days, and then found buyers enough to push to new highs. This is a strong sign, and so I expect the uptrend to continue. For Educational and Information Purposes Only
Option Volatility Now we will dive into the option metrics that can be used to formulate a trade here. The first step is to look at the Implied and Historical Volatility to see where we are relative to recent history: Again, there are a few interesting notes here. Implied Volatility has been very depressed during the market consolidation, but Realized Volatility has been above that level. Yesterday, with the breakout, Implied Volatility increased. Yesterday saw a fairly aggressive buyer of the June 23 rd $29.5 calls and this helped get the market excited. I tend to agree that the market will go higher, but the options in that term are now a bit expensive (more on that later). The focus for me now is that while Implied Volatility has increased off of lows, it is still cheap relative to both Realized Volatility and the historical average Implied Volatility, and so I expect we can construct a bullish long call or call spread trade. Options Market Structure Putting this all together, we can now look at the options market to see what expiration we may want to focus on as we put together the final trade construction. The first things we will want to look at are the term structure of Implied Volatility and then the Open Interest in strikes that are close to expiration. 2
Screenshot from LiveVol I am going to focus on the July expiration today for a couple of reasons. First, the Implied Volatility at the front of the term structure is now aggressively bid due to yesterday s buyer of calls mentioned before. I also want to note the continued choppy trade in the overall macro indexes. I do not believe we are going to be in a one-way higher market over the next couple of weeks, and while WTW can continue without a trend in indexes, it is a lot easier for any stock to trade higher if macro indexes are acting as tail winds. I also see very little in Open Interest of significant importance to this trade other than the trade yesterday. That call buyer should be a tail wind as the volatility market makers who are short will need to buy stock into a rally. The Trade Putting this all together, we will now choose our strike. I expect the stock to easily burst through $29.5 and like move to $31+. If the buyer of yesterday s calls for around $0.40 was not expecting a move to $31+ quickly, he would have simply bought the stock due to the risk/reward profile of those calls. With the Implied Volatility pick-up yesterday, I also like the idea of going with a call spread to improve our odds of success and not be long quite as much Vega. The July $30 and $33 calls are roughly the same Implied Volatility and plays well for a move into the low $30s. Today, I will be looking at the July $30/$33 call spread for $0.75. 3
P Pandora Media Inc Technical Chart To start, we will look through the equity chart for P to see what we think the market should do next: When I saw this chart action on Tuesday, I thought the bottom was in. We had a nice hammer candle after hitting new lows, and that rally was on volume. All we needed to do to confirm this was to see a rally on Wednesday that took the stock above Tuesday s highs. Then, we could start to trigger some short-covering and new longs. The market failed to do so, and now there is no clear sign of a bottom. In fact, those who bought off those technical signals and the news of a SIRI investment are now caught and more likely to be stopping out of their positions than adding to longs. This chart is shaping up to look very bearish in the immediate term. There are fundamental reasons to expect that there might be a floor (takeover speculation), and so anything I do on the bearish side will have to be done because we are getting cheap leverage. So, I will take a look at the options market to confirm that this cheap leverage does exist. Option Volatility Now we will dive into the option metrics that can be used to formulate a trade here. The first step is to look at the Implied and Historical Volatility to see where we are relative to recent history: 4
This is a perfect chart for this trade. Implied Volatility is decreasing as much of the option flow previously was built off call buyers amid takeover speculation. But, we re also getting a pick-up in Realized Volatility because of remaining longs stopping out of their positions. I can certainly expect that long Vega and Gamma are both attractive trades here. This means I am now very intrigued by what cheap puts I can buy for a quick break. Options Market Structure We will again look at the Implied Volatility levels for each expiration and then review the Open Interest to determine where we will want to place the option positioning. Screenshot from LiveVol I want to take this trade in a shorter term than normal for my bearish plays. This is because I feel that the move is either going to happen quickly or we have already 5
found our bottom. In the former case, I want to be long Gamma and have cheap puts that will increase in value quickly. In the latter case, I want to have a reduced total cash outlay for each option. That positions well for a look at the June 30 th term. The Implied Volatility is a little bit lower than the June 23 rd and allows for a break to occur in the next 2 weeks. Given the recent move and the previous driver of option flow (takeover chatter), there is very little Open Interest below $7 on the options of any significance. There is no Gamma hedging going on from the long or short side as we break. The Trade Putting this all together and given my thesis, there is not much debate for the strike here. I do not know how low the break will be if we hit stops. It could be to $6.50, it could be to $6. It could be lower. I will be closely watching the charts for signs of a bottom once we do break so that I don t end up staying in for too long with limited time to expiration. With short-term options in a low dollar stock, I want to be long the next strike that s out-of-the-money: the $7 put. As mentioned, June 30 th provides a good balance of cheap cost, high leverage, and just enough time for the market to break to new lows. Today, I will be looking at the June 30 th $7 put for $0.17. Good luck to all and if you want more help with understanding options, risk management, or trade construction, keep an eye on the Trade Academy Course Offerings which will be coming soon! 6
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