Michael Evans April 27, 2012

PROMINENT hedge fund manager and short seller Jim Chanos has singled out Fortescue Metals as a ''value trap'' stock, telling a New York conference that shares in billionaire Andrew Forrest's company will fall ''materially''.

In a presentation to Grant's Spring Conference, a private investment forum, this month, Mr Chanos, the boss of Kynikos Associates, told investors he feared iron ore miner Fortescue had ''a somewhat promotional management team''.

He singled out the company headed by billionaire Andrew ''Twiggy'' Forrest as the global example of a ''value trap'' in the ''iron ore rush'', adding that he was betting against the company.

''In our hedge fund, we are long BHP v Fortescue and others,'' said Mr Chanos, according to an account of his presentation in Grant's Interest Rate Observer, the publication of the conference organisers.

''BHP is a much more stable company. They see the cycle more than others do, they've been through it more than others have and it's been an interesting hedge for those that play it that way.''

Mr Chanos was the first big US investor to expose Enron as a fraud. He also famously bet against Macquarie in 2007, saying the investment bank's famed model could not last.

A client of mine sent the above article to me and thought it would interest me.
He was right. 
It spured me to look at FMG's options actions.

FMG closed at $5.63 on 27 Apr 2012.

1)   CALLS. High volume has been building Thurs and Fri last week. Weekly calls traded increased by 213% whilst puts were higher by 83%. On Friday, Jun 625 calls attracted 1 large trade. The volume executed in this series alone and by just 1 broker represented about 34% of the overall calls traded on that day. This trade looked like initiated on the buy side by the broker.

However, despite the buying, this trade did not look like the opening of a bullish trade though. On observing some transactions in this series executed back in mid March, it looks this trade on Friday was more of a closing trade, taking profit by buying back calls sold in mid March, and not a opening of a long bullish trade.

2) PUTS increased as well. On the puts side, 42% of the volume for Friday was over a combo trade commonly called bear put spread. The volume was attributed to the buying of Jun 550 put combined with selling of Jun 500 put. The trader is trading a bearish view on the stock.

3)   Another indicator of interest is its volume. This huge increase of volume was similar to what we saw 5 weeks ago, week ended 23 Mar. FMG hit a high of $6.18 then and we saw similarly huge volumes. The stock fell back following that volume pattern. Last week, it looked quite similar. The stock hit a lower high of  $6.03 this time and has fallen off since then as well. The difference at the moment is that in the mid mMay peak to trough, it stopped at $5.66, this time the peak is lower and the trough seems to lower as well. On Friday the stock already closed at $5.63.

From options actions, there seems to be some pressure on the downside on the stock. The increased volume on the calls may just be masking the storm brewing in the stock.

XJO closed at 4211 on 9 Mar 2012, rising 41 points for the day.

1) Volume

Weekly overall options volume (index + equities) was down slightly (5%)  last week including that of Friday’s despite the XJO rising 41 points for the day and equities weekly volume higher by 1%. 

Trading in XJO options though, increased by 14% for the week. It showed that the dropped off in options volume was due to lower positions being taken in individual stock options with increased trading in XJO options.

On analysing each of the call and put components separately on the XJO options, it was found that the put/call ratio for the week was at an average reading of 1.31, though it was a better one of 0.8 on Friday.

2) Volatility

An interesting indicator to keep track of is the CBOE Volatility Indiex (VX) Futures* to get a sense of expectations, it looks like there is a gradual increase expectated of the VIX. With current reading at 17.11, the VX futures are calling for it to be closing at 19.8 this week for its Mar expiry with an incline all the way to above 25 in June. The Implied Volatility in our market is not displaying dissimilar trend.

(*VX JAN12  "F" expiry was at 21.95; Feb12 "G" was 19.0512;  with reading on  9 Mar 2012 as follows for: Mar12 "H" futures is 19.8;  APR12 "J" is 23.2;  MAY12 "K" is 24.85;  Jun12 "M" 25.85 )

What about the XJO?

The XJO options' current Implied Volatility is at a very level again of early 16. It has been here a few times in the last few months. If we were to look at the XJO calls and puts separately, we will find that the Implied Volatility for the calls for the next few months out lower than the puts. The puts'  Implied Volatility are at levels even higher than that of the historical levels.

What are these indicators implying?

Overall, with index call options on  low volatility and put/call ratio at average levels whilst puts' volatility elevated, there is a risk of the current market remaining flattish or capped to the upside with risk on the donwside.

Following my post last week on 27 February entitled" Is NCM likely to try for $36 again this week?", which I said the stock is likely to be "cooling off", which it had this week, but more than cooling off, it lost 5.5%. With this new development in momentum, there has been a change in one of its indicators as well.

NCM closed at $32.57 on 2 Mar 2012

NCM definitely underperformed the market for the week ended 2 Mar 2012. Having lost 5.5% for the week, the question top of mind for investors may be "are there anymore downside?" and "are there any signs of possible turn around yet?"

Let's have a look at options volume first.

Options volume in NCM dropped back down to a more normal level last week. Trading in calls dropped off significantly whilst trading in puts led the stock through out the week as the stock fell. Not a positive turn around sign just yet.

 Implied Volatility (IV)

This is one significant indicator that stood out for me . After staying at a low Implied Volatility of around 24% for about 5 weeks,  it has started to sneak up last week, closing at the highest level of 26.76 in 5 weeks. This makes me uncomfortable. As once IV creeps up from  a low level and is no longer staying flat, it can  threaten to continue to head higher. If that is the direction the IV is heading, from this high 26ish, it can go all the way up to 34. This was the level it rose to end of December last year when NCM fell to a low of $29.60 This is a warning sign for me, especially if its IV would continue to rise in the coming week. $29.60 or there abouts is my target. Stay out or go short for now.

During last week's trading  ended 24 Feb 2012, we saw NCM hitting a recent high of $36.10 on Thursday. This has been a good run for NCM from $31 since early January 2012. (roughly 16% gain).

The strength in the NCM's share price last week coincided with a very strong week in call options trading. Trading in calls mirrored the trend of the stock and peaked on Thursday.  Total increase in calls traded was significant.  There were about 120,000 call contracts traded in the week, much more than the weekly average of about 40,000 contracts.  But, on Friday, there was a switch in trading. Calls dropped off in volume heavily whilst  puts increased. This signaled long positions being closed and trading on the long side of the stock lessening.

Looking at the other side of the options trade, the puts, especially those on Friday as puts picked up on Friday, were not all protective trades or buying of puts for downward play on the stock. Some of the large transactions on the puts side were attributable to a bullish strategy called bull put spread, with selling of the put at the $34.51 strike. This is coupled by larger quantities of calls for a bull call spread with the selling at the $35.30 call strike.

The options actions in NCM seem to be signaling a cooling off on the long side and a big plunge is not necessarily expected to follow. This is also observed from the stock’s Implied Volatility, which is very flat on both the calls and puts compared to their historicals.

The indicators are giving a hint of a stock that is likely to trade in a small range for a while before deciding which way to go. So, unlikely to try for $36 again in the short term, but more likely to hang around the $34/$35 levels.  Selling options is most lucrative for stocks displaying this pattern.

For week ended 10 Feb 2012, FMG low/high was $5.15 – $5.47

FMG had a strong week rising 3.35% last week.

It was also a big week in options for FMG, especially on the calls side. Weekly call volume was 6 times more with puts, with put volume having remained the same. Traders were playing the upside on the share via calls.

Interest seemed to have been centred on a particular strike, the Feb $5.50 calls. There were active buying and selling of the series through out the week. Total contracts traded in the Feb $5.50 calls for the week was 57,000, 26% of total calls traded, especially during Monday and Wednesday last week when FMG peaked for the week at $5.47.

The $5.50 level is now also the largest Open Interest in Feb. With the stock reporting on Wednesday (15th Feb) and analysts expecting a strong result, $5.50 is key. Looking at Implied Volatility for some indications, it seems like calls IV are much higher than puts as well, the Feb ATM 525 calls IV are at 40 vs the puts at 32, showing the popularity of calls. Moreover, protection via puts did not seem top of mind or sought after in the stock last week.

The trading pattern on the stock seems to be throwing up the question, “is FMG likely to break above $5.50 this week, with results being the catalyst?”

Well, for those who like a punt, weakness in the stock early in the week may present some opportunities!

Week ended 3 Feb 2012: Volume in options trading was 2.03m vs 3.596m in equities. This is a drop of -27% in options contrasting with an increase of  +62% in equities trading from the week before. This is not a normal pattern in volume between the two.

The last time we saw this similar pattern was in the week ended 2 Dec 2011. That week,  options volume was down by -31% with equities higher in volume by +17%. The XJO was at about the same level as well, it closed at 4288 then. The XJO touched a high of 4294 this week. The only difference between the two periods is that in the week ended 2 Dec 11, the XJO had a huge jump of 7% in the week whilst this time, the XJO did a slow climb since early Jan12 of a 4.7% rise.

If we consider the similarities between the two periods of some weight, then perhaps what happened after 2 dec week, may have some implication for the XJO in the upcoming week.

After the 2 dec week, the XJO fell from the 4288 level in 4 consecutive weeks(including the holiday periods) losing a total of -5.5% to 4058.

Though this one observation is not sufficient to call the market down, but what had been evident last week was that options traders had had lack of conviction on the direction of the market, hence took less positions and could also be a defensive move in not taking new positions with a cautious stance.

It's interesting to see if the 156 points jump on the DOW over the weekend would be sufficient to tip options traders to the bullish side of the market.

As for me, the drop of  5.5% after 2 Dec 2011 would still be at the back of my mind.

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. 

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 3^rd 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.

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)?

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!

Strategy:

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.

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.

What a strong recovery in the resources. I had formulated strategy below but did not have time to post it this morning. It has closed up at least 20% return at the end of the day. Here it is anyway, should there be another opportunity in the next few days to implement it. WY
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Last week (ended 21 Oct 2011) FMG had fallen the most out of the three resource stocks FMG down 13%, RIO down 8.4% whilst BHP has held steady down only 3.2%.

Closing at $4.25 on Friday (21 Oct 2011), its close to the $4.00 level it fell to in early October before rising to around $5.15.

It's a good chance FMG will move back up to the early $5.00 like what it did 2 weeks ago.

Supported with third quarter result on target, progressing well to expand to 155Mtpa,with cash of US$2.1b and US$4,3b expansion work committed.

A $6k spend to take advantage of impending turnaround.

Buy Dec11 FMG $425 call and sell Dec11 $525 call
for net cost of  41c

The spread had a net delta of about 0.3 on Friday's close. 
A $1 rise on FMG will return about 30c to the spread, doubling money.

FMG.ASX (last $4.95)

There was huge volume on FMG options on Friday. In fact its weekly volume was 3 times that of the week before and about 70% more than the last 4 weeks’average of 100,000 weekly contracts. Though trading in calls doubled, but trading in puts quadrupled.

Trading on the call side tells some of the story of its trend. Most trading in calls seemed to have been buying and are mostly of out-of-the money calls as well, with high exercise price and low option price, some of these are like the Oct $650 or Sep $550 calls. These could be related to closing of sold call positions or new longs. Overall, the low volume on call trades show a lack of  stong conviction buying on the stock.

On the puts though, they were more varied. Some large quantities look to be rolling of Sep positions like the $550 puts to Oct, to reduce early assignment risks; others selling of Oct $500 puts and various other combination trades.

What stood out for FMG is not just the elevated volume but also the heightened implied volatility. Its daily average implied volatility on Friday was at 44, that’s higher than the most recent high of 42.99 in early August this year when FMG was at around $5. This higher level of implied volatility is in sympathy with Friday’s share price which has broken below $5.

It then begs the question, how high its implied volatility can possibly go? This will bring us back to the next level reached in Jul 2010 when FMG’s implied volatility climbed to as high as 51.5. FMG was as low as $4 then. This may be the next level down should there be a further sell off in the resource sector.

Buying options does not always work and when it does it delivers huge potential profits.

This could be the time for it. We want to limit downside, but leave upside uncapped.

Just a $10k spend will do the job for now.

ii) Spend about $4600 on
Buying 40 ANZ Dec11 $19 calls for $1.15 per contract (ANZ around $18.85)

If ANZ rises above $20.15 in early November, exercise the call, buy share and earn the 74c fully franked dividend as well.

If not, just sell a higher value calls if ANZ were to go higher from here.

ii) Spend $5700
Buying 15 RIO Jan12 $68 calls for $3.80 (Rio around $63)

Sell for profit

MYR closed at $2.08 last Friday 16 Sep 2011.

During its results on Thursday (15 Sep), management announced they expect sales to be  flat  in FY2012 with a net Profit of not more than 10% below that of FY11 (it's expecting for a better Christmas this year!).

Based on the share price which has fallen since then, it looks like the market has not fully embraced management's view.

Trading in puts have increased last Thursday and Friday as well. The series attracted large quantities were the Oct $1.95 put and Nov $2.00 put. With $2, being the lowest level for the stock so far, which will be a support level, investors are getting some protection at the $2 level, just in case. Moreover, with MYR expecting to go ex-dividend with 11.5c fully franked dividend on 26 Sep, stock is expected to slide down slightly after as well.

Other retailers - HVN and DJS did not have similar negative sentiment last week.

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.

Some trades to bare in mind, when we next get a break above 4300 on the XJO!

XJO last trading at 4150, 16 Sep 2011

This is a trade for those who are a little more aggressive (not for super funds).

Capturing the wave of the market and its recent ceiling at the 4300 level.

There are 34 days to expiry and if you share the view the XJO can't go too far higher than 4300, then the trade below is for you.

Sell oct 4300 call and buy oct 4500 call for a net 50c credit

Max loss is $2k per contract

eg. risking $10k, generates $2.5k income for 34 days (25%)

1. STO.ASX (9 Sep last $11.52)

STO stood out with its high volume of trading on calls on Friday, 18000 contracts. Second highest volume behind the XJOs.

The series that attracted high trading volumes were in Sep 1225 calls and Sep $1178 calls. They don’t appear to be opening trades though, appear more to be closing of calls written or rolling of bear call spreads.

Looking at calls traded on STO in the last two weeks, the last time it attracted more than 10,000 contracts per day was on 1 September, when STO hit an intraday high of $12.19.

Options trading pattern may be suggesting the market has identified a trading range of the stock, $12.20 to about $11 for now. Strategies have been positioned at the range.

2. WPL (9 Sep last $34.02)

With WPL trading around the $34 level last week, options volume on WPL has dropped off . Its weekly volume of both calls and puts together were only about 36% of the week before.

Its Implied Volatility have calmed down as well for its Sep and Oct expiry terms and they have gone below Historical levels by 9% and 7% lower respectively.

With this lower volume and lower Implied Volatility, this may be signal that aggressive selling or shorting is slowing in WPL and could be start of base-building around the $34 level.

3. ORG.ASX (9 Sep last $13.20)

Total options volume on ORG last week had been steady compared to the week before, but trades were more tilted towards the puts. There were 80% more puts traded than the week before.

In analysing its open positions in Sep puts, the top two largest Open Interests were the Sep $1507 and $1459 put series which are quite deep in the money comparing with ORG’s price of about $13. The higher volume on the puts could be attributable to rolling of those puts to reduce risk of assignment.

Trading on the calls though, the lower volume may be a signal of a lack of opening of fresh positions in the share. 

Rio closed at $72.05 on 2 Sep.

This looks like a follow on from the failure to stay above $73. The key day was last Thursday when RIO touched a high of $73.81 and reversed down to close at $73.08.

RIO’s Options Actions

On the call side, volume is like the week before. Removing the anomaly of a crossing of 35,000 contracts on Sep11 LEPO on Wednesday last week, number of call options traded were at an average of 12,000 daily contracts. The volume on put, on the other hand, has dropped off to just 9000, this is a drop from 20,000 last week and a more average of about 15,000 daily under normal trading conditions.

Volume is showing traders were not aggressively going short on RIO.

RIO’s Implied Volatility

RIO’s Implied Volatility stood out with a sharp fall. Its  30, 60 and 90 days options, ie next three months are displaying low volatility. Especially with the 30 day’s, its Implied is sitting at about 26 versus the historical’s of 46 .

This is reflecting the smaller range the stock has been moving in the last 2 weeks and the expectation of it continuing in a range in the short-term. 

The market had some excitement on 1 Sep last Thursday as the XJO rises above 4300, touches 4354 and closed the day at 4307.

On that day, Thursday last week, we saw the options market got excited. The number of calls traded were at 25,000 contracts, above the average of about 14,000 daily contracts the week before. That is only half the story as puts traded were higher than average as well. On that day, there were 31,000 contracts of put traded versus the daily average from the week before of about 22,000 contracts.

The next day, on Friday as the XJO failed to maintain its lead above 4300, options market got disappointed and the number of calls traded fell to just 17,000 contracts.

But again, what’s telling is the number of puts traded last Friday, it has remained at the higher than daily average level with 30,000 puts traded.

Options Action Implication

Options market is expecting more weakness on the XJO as it failed to stay above the 4300 level.