A Wild, Wild Ride

Here’s How to Play the Volatility on Both Sides

By Bryan Bottarelli
Thursday, March 01, 2007 11:02 AM EST
Thu, 1 Mar 2007 16:02:00 GMT

Dear Bottarelli Research Member,

With the Dow opening lower by 200 points, make sure that you understand one important point: In times of market “corrections” like this, you can throw the technical indicators out the window.

When you’re in the midst of panic selling, the only thing that matters is emotion — and the emotions this morning were clearly running for the exits.

Another important point: When you’re in the midst of panic selling, volatility shoots through the roof — sparked by big price swings and seemingly irrational behavior. For example, the Dow dropped 200 points first thing this morning, but then quickly recovered 170 of those points and traded lower by only 30 points just before 9:30am. What massive price swings! Action like this makes the entire market ask themselves, “is it time to buy calls — or is it time to add puts?”

To be perfectly honest, I think the best action play is to CAREFULLY DO BOTH.

Of course, the bias will be to ride the most recent trends — meaning we get posited to ride a continued fall. After all, as I mentioned this morning, the last market correction we experienced was in May of 2006 when the Dow fell 8%. The correction before that happened in October of 2005 when the Dow fell 5%. Then after that, the next correction happened in April of 2005 when the Dow fell 8.96%. And finally, in October of 2004, the Dow corrected by falling 9.72%. Average all of them out and you’re looking at a 7.92% correction — and right now we’ve only seen 3% to 4% of that (depending on if you take intra-day or closing numbers). As a result, I’d like to establish one new put position on a stock that has experienced a big run-up — and could now be looking at an equally big fall. That candidate is PetroChina (PTR – NYSE).

PTR

Since the Chinese markets are the ones the sparked this U.S. sell-off, it’s only fitting to play puts on the company that combines the two most volatile market sectors right now: China and Oil.

As you can see, PTR dropped over $4.00 today pushing it underneath its 200-day moving average at $111.00 per share. A quick move to $105 could be in order, so let’s add PTR puts now!

PLAY: Buy the PTR April 110 Puts (PTR PB) at or under $3.90, good for the day. Current bid/ask spread is $3.50 to $3.80. Place a protective stop loss at $2.00.

At the same time, let’s play calls on a stock that has been very strong in the midst of this week’s selling pressure, and that stock is Valero Energy (VLO – NYSE).

VLO

Make no mistake, I’m very bullish on VLO going into the spring and summer months, and today’s slight weakness could be an opportunity to buy longer-dated calls on the cheap. In fact, even if today’s VLO calls decrease by 50% in value, I’d have no problem buying more of them to ride the upside over the longer-term — because eventually I think we’ll get rewarded. Here’s the play:

PLAY: Buy the VLO June 60 Calls (VLO FL) at or under $3.00, good for the day. Current bid/ask spread is $2.75 to $2.90 per contract. Since I’d like to hold this position despite any market dips, place a protective stop loss at $1.10.

Also, continue to hold the second half of your DIA March 126 Puts (DAW OV). They’ve traded as high as $5.50 in today’s action, so let’s continue profiting off the protection that they offer. Until then…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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