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IVolatility Trading Digest™ Blog
Monday December 02, 2013
Volume 13, Issue 47
Seasonally Bullish - IVolatility Trading Digest
Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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So far this year, the S&P 500 Index is up 26.6% and December is statistically a good month, so the odds favor further gains going into yearend. However, be aware of profit taking in several highflying stocks that led the advance in October as money began rotating into the laggards and those with a seasonal wind at their backs. We have more in the Strategy section below right after reviewing our market indicators. Next, we have an update for a previous Valero Energy Corp. (VLO) suggestion.
As for how much higher the market can go, since there is no overhead resistance, here is one guideline that may prove useful at some time in the future.
"… then sell all your stocks when the market has ceased to advance on good news."
Fred C. Kelly
S&P 500 Index (SPX) 1805.81. After another Key Reversal last Monday that failed to meet the measuring objective of a lower low the next day, it continued higher in a narrow trading range making higher lows all week on light Thanksgiving week trading volume. On any decline, there are now two support levels to watch. The first is the November 18 high of 1802.33 while the second is the previous October 30 resistance high of 1775.22. Although we are not expecting a test anytime soon, the upward sloping trendline is now 1692, about 6.3% lower.
CBOE Volatility Index® (VIX) 13.70. Increasing 1.51 points since our last review in Digest Issue 45 "Smooth Sailing" VIX is beginning to reflect more caution by options participants as reflected in the futures premium below. Perhaps it was increased hedging activity or just due to light volume last week.
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.
The day weighting applies 60% to December and 40% to January for an average premium of 5.33% shown above. Our alternative volume-weighted average between December and January, regularly found in the Options Data Analysis section on our homepage, is slightly higher at 5.41%. Both premium measures are in the lower part of their ranges in yellow light territory suggesting a bit more caution may be prudent.
With a current 30-day Historical Volatility of 57.96 and 56.02 using Parkinson's range method, the table below shows the Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon Friday's closing option mid prices along with their respective month's futures prices, since the options are priced from the tradable futures.
The Implied Volatility Index Mean (IVXM) now at 56.93 and very closely aligned with the historical volatility measures, advanced 2.18 since our last review although the SPX also advanced.
All of the Implied Volatilities along with the Historical Volatilities and Greeks for the VIX options based upon the futures prices are on our Advanced Options page, found by clicking on the " market close" link shown near the top of the page.
US Dollar Index (DX) 80.68. Very little has changed since our last review in Digest Issue 45 "Smooth Sailing" when we declared the downtrend over. However, there is now considerable resistance around 81 that stalled the advance. From a five-year seasonal perspective, November is one of the better months with December lagging slightly.
10-Year Treasury Notes (TNX) now yield 2.74% having closed above our downward sloping trendline from the 2.98% high on September 5. The 13 basis point advance on November 8 following the better than expected October employment report dispelled any uncertainty about a change of trend from lower to higher. We suspect any further changes will be dependent upon the November employment report due on Friday. A better than expected report will mean higher interest rates, a stronger dollar and weaker commodity prices.
iShares Dow Jones Transportation Average Index (IYT) 129.94. Lower crude oil prices should continue supporting the transports, which have been outperforming the S&P 500 Index since the middle of September. Seasonally crude oil prices typically bottom in January so the transports should continue doing well unless derailed by news of an unexpected economic slowdown.
NYSE McClellan Summation Index 344.89. If there is a weak link in the bullish argument then it's lagging market breadth. Since our last market review in Digest Issue 45 "Smooth Sailing", our preferred market breadth indicator declined another 48.66 points including the tepid 19.94 advance last week. The divergence between the new highs in the NYSE Composite Index and the number of advancing issues compared to the decliners is a concern that needs to be favorably resolved in order to sustain the market advance.
CBOE S&P 500 Skew Index (SKEW) 130.82. SKEW measures the purchase of out-of-the-money S&P 500 Index puts that require a very large downside move to profit from long put positions. An increase of this index indicates greater expectations for an extreme down move.
After advancing to 137.06 on November 18, it quickly dropped down to 124.63 three days later only to rebound once again. Sharp advances followed by quick declines are normal but lately the magnitudes of the swings are more pronounced. Once again closing above 130 it continues to suggest relatively inexpensive OTM puts are favored for hedging.
While it may be easy to conclude the odds favor long positions going into yearend it may be more of a challenge to select the individual issues since there has been profit taking in some of the previous market leaders that may have been fundamentally overvalued. Tesla Motors (TSLA) 127.28 and Facebook Inc. (FB) 47.01 are in this category however, both now appear to be attempting to turn higher once again. Alternatively Apple Inc. (AAPL) 556.07 made its correction in September and has now broken out to close above 550.
We continue to suggest long positions in the relative strength leaders like those in Digest Issue 44 "Relative Strength Update" especially those with good option volume and liquidity although they may be subject to profit taking before yearend. For those who do not want to dance with the professional money managers as they rotate from one issue to the next, often in the same sector, consider a long call spread position using the iShares Russell 2000 (IWM) 113.51, considering the January effect, when small capitalization stocks outperform the market, has recently been starting in December.
Another notable event worth considering was the breakout of the WisdomTree Japan Hedged Equity (DXJ) 50.31. With the decline in the yen below 100, Nikkei equities are advancing once again. With good option volume and liquidity, consider an out-of-the-money long call spread.
Returning to the seasonal theme here is a work-in-progress update for a seasonal suggestion made in Digest Issue 42 "Earnings Mix Bag."
Valero Energy Corp. (VLO) 45.72.
Since WTI crude oil appears to be in a seasonal decline and the spread between Brent crude has widened to 16.84 basis January futures, the stock continues to advance in anticipation of higher profit margins when they report 1Q earnings at the end of January.
In Digest Issue 42 "Earnings Mix Bag", we suggested buying a January 41 call and selling a January 45 call creating a bullish call spread that partially hedged declining time value and changes in implied volatility. We booked the position October 28 for a .96 debit. Marking it to Friday's market the value was 2.78 representing a 190% gain in one month. Now since the stock price has reached the short call strike price, the time has come to roll this one up.
Here are the two trades needed.
With this adjustment we will book a 1.82 gain (2.78 - .96) and still have a long position expecting the stock to reach 50 before the January options expire. Use a close back below the last pivot just under 42.50 as the SU (stop/unwind).
The suggestion above uses the Friday closing middle prices between the bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
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Although last week's volume was low due to Thanksgiving the market continued higher and since December is statistically a good month, the odds favor further gains going into yearend. The minor correction that we had been expecting looks like it may not occur before yearend even though our market breadth indicator continues to lag the advance.
Follow us on twitter for more ideas from our scanners and other developments.
In next week's issue, we will fire up our ranker and scanner tools in search of more interesting trade ideas.
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 way to find them is the Table of Contents link in the blog section of our website.
As 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. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website. If you would like to receive the Digest by e-mail let us know at Support@IVolatility.com.
IVolatility Trading DigestTM Disclaimer
IVolatility.com 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".