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« May 2016

IVolatility Trading Digest™ Blog

Volume 16 Issue 18
Looking for Hedges [Chart]

Looking for Hedges [Chart] - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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With more than half of the S&P 500 Index companies reporting first quarter earnings, the results continue to be underwhelming with a few notable exceptions. Unless more companies join the ranks of the exceptions this week, the decline that began Thursday will likely continue. This week’s brief market review includes and updated S&P 500 Index chart showing the close below the key upward sloping trendline followed by a US Dollar Index comment along with SPDR S&P 500 ETF and ProShares UltraShort S&P 500 hedge suggestions

Review NotesS&P 500 Index (SPX) 2065.30 closed down 26.28 or -1.26% for the week, well below the upward sloping trendline, USTL that began February 11 at 1810.11. For now, resistance from long-term downward sloping trendline, DSTL from the May 20, 2015 at 2,134.71 as shown the last week’s Digest Issue 17 "Trendlines Converge" [Chart] remains intact.




Like a boxer in the twelfth round, SPX looks like it is beginning to stagger a bit after the long climb up from the February 11 low. Look for the first support at 2050 S1 above and then more at 2000 S2. It could turn higher again at either support and then or go back up to retest the DSTL, but at 24 times reported 2015 earnings thoughts of further upside seem overly optimistic unless earnings perk up.

CBOE Volatility Index® (VIX) 15.70 closed up 2.48 for the week after making an intraday low of 12.50 on April 20. Based on real-time prices of options on the S&P 500® Index, VIX reflects investors' consensus view of future (30-day) expected stock market volatility.

The table below shows the VIX cash compared to the next two futures contracts as well as our calculation of Larry McMillan’s day-weighted average between the first and second months.




With 12 trading days until the May monthly expiration, the day weighting applied 60% to May and 40% to June for a 12.87 % premium shown above. Our alternative volume-weighted average between May and June regularly found in the Options Data Analysis section on our homepage was slightly lower 12.25%

While day-to-day VIX changes offer little forecasting insight following the VIX futures premium helps since it measures expectations of tactical professional traders and money managers using VIX futures and options for hedging long portfolio risk.

The premium measures the amount the futures trade above or below the cash VIX until expiration when the front month converges with the cash VIX. Depending on the time to expiration premiums for normal term structures during uptrends are 10% to 20% and decline when the VIX advances faster than the nearest future as the market declines and/or the futures contract nears expiration. Premiums less than 10% suggest caution and negative premiums indicate oversold conditions. Last week the premium began at 20.44% and ended Friday at the low of 12.25% as VIX advanced.


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Foremost Indicators

The US Dollar Index along with gold was the most notable indicator last week.

DollarUS Dollar Index (DX) 93.08 down 2.04 points or -2.14% for the week after closing below support at 94 and testing the lower end of the 93 support range before closing just above the low. The main driver was the advancing Japanese yen after the BOJ declined to offer more stimulus measures along with the weaker than expected first quarter US GDP report at .5%.


While gold broke out and crude oil continued marching higher, adding 5% as June futures closed at 45.92. However, the declining dollar failed to support equities this time suggesting waning momentum while prompting risk reduction and short yen carry trade closing. However, now overbought the yen could quickly reverse. The macro story is all about currency volatility.

StrategyWhile April is seasonally favorable for equities, May is typically one of weaker months of the year. The decline that began Thursday may have been a combination disappointing earnings along with front running an anticipated May decline. If so, it adds credibility to proposition that sector rotation or sector churn when traders push up one sector until there are no more buyers and then rotate into sectors where there are no more sellers. Although widespread advances made in both industrials and basic materials suggested the global economy was about to accelerate it appers any improvement may be limited to China as the first quarter US GDP report disappointed. Accordingly, perhaps the time has come to consider some hedges.

Two Hedge Ideas

SPDR S&P 500 ETF (SPY) 206.33 down 2.64 or -1.26 for the week, here are the option details.

The current Historical Volatility is 9.27 and 8.46 using the Parkinson's range method, with an Implied Volatility Index Mean of 13.63 up from 11.72 the week before. The 52-week high was 32.99 on August 24, 2015, while the low was 9.99 August 17, 2015 just one week earlier. The implied volatility/historical volatility ratio using the range method is 1.61 so option prices are expensive relative to the recent movement of the stock. Friday’s option volume was 3,454,873 contracts with the 5-day average of 2,172,230 contracts with good bid/ask spreads.




Using the ask price for the buy and mid for the sell the call spread debit would be 1.48 about 30% of the distance between the strike prices with a slight implied volatility edge. Since support is around 200 it makes a good short leg strike. Use a close back above 210 as the SU (stop/unwind).
ProShares UltraShort S&P 500 (SDS) 18.72 added .44 points or +2.41% for the week after finding support at 18 as SPX momentum declined.

The current Historical Volatility is 18.84 and 16.67 using the Parkinson's range method, with an Implied Volatility Index Mean with an Implied Volatility Index Mean of 28.42 up from 24.07 the week before. The 52-week high was 74.37 on August 24, 2015 while the low was 20.96 on July 22, 2015. While implied volatility usually rises as the underlying declines, for this ETF it’s the opposite, since implied volatility advances along with SDS. Accordingly, positions with an extra long option, like a ratio spread would add some implied volatility edge. However, for the sake of simplicity the idea below is a less complicated call spread. The implied volatility/historical volatility ratio using the range method is 1.70 so option prices are expensive relative to the recent movement of the ETF. Friday’s option volume was 35,848 contracts with the 5-day average of 16,790 contracts considerably less than SPY above but with good bid/ask spreads.




Using the ask price for the buy and mid for the sell the call spread debit would be .41 about 21% of the distance between the strike prices with a good implied volatility edge. Use a close back below the 18 as the SU (stop/unwind).

The spread suggestions above are based on the ask price for the buy and middle price for the sell presuming some price improvement is possible. Monday’s option prices will be somewhat different due to the time decay over the weekend and any price change.

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The S&P 500 Index turned lower before reaching upside resistance at the downward sloping trendline and then closing below the key operative upward sloping trendline from the February 11 low. With evidence of risk off activity and volatility in the currency markets late in the week, the time has come to consider hedging any remaining long equity portfolio risk.


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ActionActionable Options™

We now offer daily trading ideas from our RT Options Scanner before the close in the News section of our home page based upon active calls and puts with increasing implied volatility and volume.


Next week’s issue will update our market indicators along with the VIX futures premium and report on the progress of the S&P 500 Index.


Finding Previous Issues and Our Reader Response Request

All previous issues of the Digest can be found by using the small calendar at the top right of the first page of any Digest Issue. Click on any underlined date to see the selected issue. Another source is the Table of Contents link found in the lower right side of the IVolatility Trading Digest section on the home page of our website.

CommentAs usual, we encourage you to let us know what you think about how we are doing and what you would like to see in future issues. Send us your questions or comments, or if you would like us to look at a specific stock, ETF or futures contract, let us know at or use the blog response at the bottom of the IVolatility Trading Digest™ page on the website. To receive the Digest by e-mail let us know at


Need related advice on eur/usa currencies for day trades.

Posted by Terrence on May 02, 2016 at 01:00 PM EDT

Terrence, Thanks for the request. It was reported when JP Morgan was asked what the market will do, he replied it will fluctuate. As the central banks of the developed economies exhaust alternatives to stimulate growth, competitive devaluations and increasing volatility in the currency markets are likely to increase. Using our Basic Options or Advanced Historical Data service take a look at the increasing implied volatility index of the currency ETFs, such as FXE and especially FXY. Previously currency volatility was very low but that has changed. As for day trading currencies, there are many good FX advisory services providing daily commentary with greater access to information from the banks making FX markets. Jack

Posted by Jack ( on May 02, 2016 at 03:11 PM EDT

Permalink Comments [2]

IVolatility Trading DigestTM Disclaimer is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter constitutes a recommendation to buy or sell any security. Before entering a position check to see how prices compare to those used in the digest, as the prices are likely to change on the next trading day. Our personnel or independent contractors may own positions and/or trade in the securities mentioned. We are not compensated in any way for publishing information about companies in the digest. Make sure to due your fundamental and technical analysis homework along with a realistic evaluation of position size before considering a commitment.

Our purpose is to offer some ideas that will help you make money using IVolatility. We will also use some other tools that are easily available with an Internet connection. Not a lot of complicated math formulas but good trade management. In addition to Volatility we use fundamental and technical analysis tools to increase the probability of success and reduce risk. We prepare a written trade plan defining why the trade is being made, what we call the "DR" (determining rationale) and the Stop/unwind, called the "SU".