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« March 2015

IVolatility Trading Digest™ Blog

Volume 15 Issue 12
VIX Futures Premium Hedge Indicator [Chart]

VIX Futures Premium Hedge Indicator [Chart] - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Last week started with the S&P 500 Index resting right on multiple supports ready to go either way, it only needed a little help from the overbought US Dollar Index and that's just what happened as the dollar began selling off in Asia before the US markets opened. However, contrary to expectations interest rates and implied volatility declined suggesting the Fed would retain "patient" or some other dovish language in the Wednesday comments no doubt prompting some to wonder when the Fed cliffhanger drama will end. The majority opinion by far was for the removal of "patient" and they were right but the Fed replaced it with the need to be "reasonably confident" that inflation will move back towards the 2.0% objective before hiking rates, so the Fed simply moved the goalposts. The Fed cliffhanger continues.

With the threat of an immediate hike in the federal funds rate off the table equities extended the advance started Monday as the bottom fell out of the US Dollar Index. After a brief market review we take look the VIX futures premiums along with an updated hedge suggestion for CBOE Volatility Index® (VIX) options. Next, a put spread idea for iShares Nasdaq Biotechnology (IBB) follows. Finally, our friends at The Blue Collar Investor sent a timely article about rolling option positions.

Review NotesS&P 500 Index (SPX) 2108.10 up 54.70 or 2.66% for the week and well off the upward sloping trendline from the from the October 15 it now challenges the February 25 high at 2119.59. Now negatively correlated with US dollar any further dollar decline will add support to the advance. However, since some selling is likely as it approaches the previous high, perhaps a hedge like the one suggested below could be worthwhile.

CBOE Volatility Index® (VIX) 13.02 down 2.98 for the week as approaches the 12.50 support level and the low of 11.53 made December 5, 2014.

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 85% to April and 15% to May for a 25.94% premium shown above. Our alternative volume-weighted average between April and May, regularly found in the Options Data Analysis section on our homepage, is slightly higher at 28.31%, at the highest weekly premium in the last year. Premiums for a normal term structure are 10% to 20%; while premiums above 20% are unsustainable suggesting a lack of enthusiasm for VIX hedging often occurring around market highs suggesting overbought conditions associated with pullbacks. Alternatively, premiums less than 10% suggest caution and negative premiums indicate an oversold condition. Last week the premiums began at 7.80%, were 20.19% Thursday, ending the week at 28.31%.

In the one-year chart below, we marked where the week ending premiums were above 20% in support of our previously surmised guidelines above.


The data corresponding to points 1-7 above:


Although this limited sample is hardly conclusive evidence, hedging strategies implemented near points 1, 3, 4 and 6, would have proved worthwhile. It could also be important as a short-term indicator since the premium was only 7.80% Monday and then only exceeded 20% Thursday and Friday acting much like a contrary overbought sentiment indicator, but based upon professional grade hedging activity.

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strategyLast week in Digest Issue 11 "S&P 500, US Dollar and Crude Oil [Charts]" we noted a pullback in the US Dollar Index was likely to begin Monday or Tuesday regardless of the comments after the Federal Reserve Open Market Committee meeting Wednesday and indeed it did. Now the biotechnology sector along with Health Care Select Sector SPDR ETF (XLV) 74.90 appears overbought and due for similar pullbacks after positive biotech news Friday. We have a put suggestion foriShares Nasdaq Biotechnology (IBB) below, but first a VIX update since if the hot biotech group corrects as expected it will likely take the entire market lower.

CBOE Volatility Index® (VIX) 13.02

Last week’s suggestion was a disappointment since VIX declined Monday contrary to expectations, and then declined substantially both Wednesday and Friday. While Wednesday’s decline can easily be attributed the Fed comments, Friday’s could be related to the bullish activity in the biotech sector.

Now with VIX approaching the previous lows that should act as support, a short put position added to a long call will increase the delta and reduce the cost without materially increasing the risk since volatility will not go to zero and the April contract has more than three week to expiration.


Based upon the ask price for the call and the bid for the put the debit is .25 with a delta of 1.00 representing a lot of hedge power at a small cost. The only issue here is getting the position established before the market declines.

 iShares Nasdaq Biotechnology (IBB) 366.52, up 21.19 or 6.14% for the week - too far too fast?

The current Historical Volatility is 15.65 and 17.26 using the Parkinson's range method, with an Implied Volatility Index Mean of 24.79 up from 24.00. The 52-week high was 39.98 on April 14, 2014 while the low was 19.37 on August 27, 2014. The implied volatility/historical volatility ratio using the range method is 1.44 so option prices are somewhat expensive compared to the recent movement of the stock, but the implied volatility will increase as the expected correction begins. The put call ratio is bearish at 3.10. Friday’s option volume was 28,206 contracts traded compared to the 5-day average volume of 15,160.

Consider this put spread idea.


With a slight volatility edge, using the ask price for the buy and the mid for the sell presuming some price improvement is possible, the debit is 1.85 an attractive 18.5% of the distance between the strikes. Use a close back above Friday’s high of 374.97 as the SU (stop/unwind).

Rolling Covered Call Positions


Selling short-term option is all about generating a constant monthly cash flow by leveraging elite-performing underlying stocks to create income. Selling a covered call creates and obligation to sell the shares to the option buyer at the strike price by the expiration date. Without action, assignment will occur if the price of the stock or ETF is one penny or more above the strike price at expiration.

What is rolling out an option out?

Rolling out is closing a near term contract while opening open a new option contract with a later expiration date. An example would be to close the March 50 call contract and open the April 50 call on the same stock.

What is rolling out and up?

This is similar to rolling out, where we close the near-term contract and open a later dated contract on the same security but at a higher strike price. An example would be to buy back the March 50 call and sell the April 55 call creating a more bullish position compared to just rolling out.

When to roll?

Consider rolling options when the strike price is in-the-money near expiration (lower than current market value of the underlying security) and the stock continues to meet system criteria in terms of fundamental and technical analysis as well as meeting common sense standards like minimum trading volume etc. Most importantly, check to make sure there is no earnings report due prior to expiration of the deferred month contract. Also, ensure that the option’s initial returns meet the monthly (or weekly) goals (such as 2-4% per month for initial returns).

To roll or allow assignment and repurchase the shares?

Rolling an option, incurs one less commission (buying and selling the option rather than selling the stock, buying the stock and selling the new option). In addition, when rolling specific returns are better estimated, since waiting the next week may or may not provide a similar return.

Click on The Blue Collar Investor link to learn about mastering the skill of selling options and much more information about becoming an elite covered call writer.

The VIX suggestion above is based on the ask price for the buy and bid for the sell. The IBB suggestion presumes some price improvement is possible. Monday’s option prices will be somewhat different due to the time decay over the weekend and any stock price change.


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Comments after the Federal Reserve Open Market Committee meeting last Wednesday eased apprehension that had been building like pressure in a teapot that a hike in the federal funds rate will occur any time soon. Accordingly, the interest sensitive underlying issues as well as the US Dollar Index began correcting as S&P 500 Index promptly bounced off the upward sloping trendline and continued marching higher. Now the previous high at 2119.59 is next upside target while the leading biotechnology sector looks overbought and due for a pullback.


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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.


In next week’s issue, we will again update all our market indicators.

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.

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 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


Follow us on twitter - every day we are busy searching our extensive database for unusual call and put volume with increasing implied volatility that we also place in the News section on our home page.

Posted by Jack on March 23, 2015 at 11:40 AM EDT

Permalink Comments [1]

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".