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« April 2014

IVolatility Trading Digest™ Blog

Volume 14 Issue 15
Goose & the Golden Eggs

Goose & the Golden Eggs - IVolatility Trading Digest™

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Goose & the Golden EggsAccording to the Aesop fable, once a Countryman possessed the most wonderful Goose imaginable. Every day when he visited the nest, the Goose had laid a beautiful, glittering, golden egg.

He took the eggs to market and soon became rich. However, before long he grew impatient because she gave him only a single golden egg a day. He was not getting rich fast enough.

Then one day, after he had finished counting his money, an idea came to him that he could get all the golden eggs at once by killing the Goose and cutting it open. When done, he did not find the source of the eggs and his precious Goose was dead.

Those who have plenty want more and lose all they have.

Digest Issue 13 "Stampede Trigger", proposed that the IPO stampede along with rotation out of "growth at any price stocks" could trigger a broader market decline, one that is now well underway.

Following our market review we expand upon these thoughts and then offer two ideas for United States Oil (USO) one long the other short.


Review Notes Clip ArtS&P 500 Index (SPX) 1815.69. Last Monday's range was lower than projected implying the market was weaker than expected on increasing volume. Then after attempting a rebound Wednesday, the decline resumed Thursday and Friday. For the week, the loss was 49.40 points or 2.65%.

The operative upward sloping trendline line from the June 24, 2013 low now crosses at 1795.12, just 1.13% lower, making a likely target this week. The last two times the upward sloping trendline was tested, it failed to hold the decline, but then reversed higher within a few days. Presuming a similar pattern for this decline, look for support around or just below 1795. In the event that fails, the next stop will be the February 5 low at 1737.92 and since the momentum is still down a test of 1795 is quite likely.

CBOE Volatility Index® (VIX) 17.03. After two weeks of complacency, VIX seems to have awoken Thursday and Friday.

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 10% to April and 90% to May for an average premium of -2.23% 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 -1.61%. We consider premiums less than 10% to be cautionary while the premiums for a normal term structure are 10% to 20%. Last week the premiums were positive but less than 10 % every day except Friday when they closed at -1.61%. While we associate negative premiums with market turns, they can be negative for several days. For example, on the last market decline the premiums were negative for almost two weeks reaching -11.44% two days before the reversal on February 5, when the premium was -4.80%. Based upon this we suspect there will be several more days of negative premiums before the market turns higher.

VIX Options

With a current 30-day Historical Volatility of 112.33 and 88.58 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.



Comparing to the range historical volatility of 88.58 implies overpriced April options with just two trading days before expiration while the May options are less expensive. Reflecting the rush for portfolio protection Friday’s volume was 1,032,406 contracts compared to the weekly average of 671,840 contracts.



CBOE S&P 500 Skew Index (SKEW) 122.59. 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.

On Friday March 14, SKEW suddenly declined 15 points closing at 112.66 taking it back down near the May 28, 2013 low of 112.47. Then the next Monday it advanced 30.61 to 143.27 making a 52-week high. We suspected a data problem, however if correct the close is once again just under the mid-point of the range in neutral territory. In the past, high readings have been associated with market tops presumably due to portfolio managers purchasing out-of-the-money puts for insurance while they are inexpensive.

US Dollar Index (DX) 79.45. The dollar was trending slightly higher until April 4 reaching 80.42 before abruptly turning lower as Treasury interest rates declined renewing expectations for a slowing global economy after China’s recent trade balance report. This would be consistent with increasing gold prices last week.

iShares Barclays 7-10 Year Treasury ETF (IEF) 102.57. The previous potential Head & Shoulders Top identified in Digest Issue 11 "St. Patrick’s Day" remains possible until it closes back above the March 3 high at 102.83. However, the current operative technical pattern appears to be a declining wedge with an upside measuring objective at 103.68, which would eliminate the previous potential Head & Shoulders Top. If so, the interest rate yield would be back down to the June 19, 2013 level of 2.31%. Here is the chart with an arrowhead indicating the area of the measuring objective equating to a yield of about 2.31%.



While declining interest rates would usually suggest a weaker economy the other possibility of funds coming out of equities and temporarily seeking safe haven in Treasuries is just as likely since crude oil prices remain high. IEF continues to be one of the more important indicators to be watching since it provides some clues as to where the equity sale proceeds may be going.

iShares Dow Jones Transportation Average Index (IYT) 131.55. The transports are no longer suggesting "all aboard" as they were in Digest Issue 13 "Stampede Trigger" and are now casting doubt on expectations for a cyclical rotation into economically sensitive sectors. Watch the upward sloping trendline from the June 24, 2013 low of 106.32 that now crosses at 128.47, just 2.34% lower for confirmation of a slowing economy, as the railroads now seem to imply.

NYSE McClellan Summation Index 717.03. The summation index is an intermediate indicator comprised of a running total of the McClellan oscillator, a leading indicator, which is the difference between a 19 period and a 39 period exponential moving average of the net difference between the advancing and declining issues on the New York Stock Exchange.

Since our last review in Digest Issue 13 "Stampede Trigger", the summation index declined 51.35 points with a 120.23-point decline last week as could be expected with the market decline.


Along with the rotation out of overvalued "growth at any price stocks" the IPO frenzy idea introduced in Digest Issue 13 "Stampede Trigger", appears to be partly responsible for the current market decline. Now the rush for performance regardless of the risk seems to be slowing as some of the scheduled IPOs are withdrawn due to lack of demand. However, there are still 13 more on the calendar this week. Interestingly, the less than successful King Digital (KING) on March 26 now 26% lower than the initial offer seems to have turned the tide and now other recent new issues are declining from their first day trading prices. We suggest the market will likely continue declining until the IPO calendar returns to normal and that may not happen soon as Weibo and Sabre are on the schedule this week along with 11 others. It seems as if too much of a good thing is like the Goose & the Golden Eggs.

Cyclical Rotation Review

While the market decline is even beginning to cast some doubt on the rotation into cyclicals, crude oil prices remain high.

Checking WTI crude oil prices we notice they went into backwardation in the first week of January and Friday reached at high of -3.23 basis May - August, that is May futures were 103.74 while August were lower at 100.51, backward to normal carry trade by 3.23. This suggests low inventories at the Cushing Oklahoma delivery point for CME futures while there appears to be plenty of supply at the refineries on the Gulf coast.

Since USO uses futures that are now in backwardation every time they roll over the near term contract they pick up some carry. For example assuming they rolled the contracts Friday they would have sold May for 103.74 and bought June at 102.62, for a gain of 1.12 or 1.08%. While it has been in backwardation for 14 weeks, there is no assurance it will remain. In addition, crude oil basis May futures and USO both appear to be testing early February highs so there could be some double top risk.

Here are two ideas, the first assumes the double top and lower prices while the second has it going into new high ground - not good for the transports or the economy.

United States Oil (USO) 37.18

First the option details,

The current Historical Volatility is 16.92 and 11.62 using the Parkinson's range method, with an Implied Volatility Index Mean of 16.99, up from 16.97 the week before. The 52-week high was 28.16 on August 28, 2013 while the low was 13.66 on December 26, 2013. The implied volatility/historical volatility ratio using the range method is 1.46 so the option prices are high relative to movement of the ETF but below the midpoint of the 52 week range. The put-call ratio at 1.10 is bearish, but not surprising as this ETF is a hedging favorite for long oil stock positions. Friday's volume was 49,115 contracts traded compared to the 5-day average volume of 34,090 contracts so there is reasonable options liquidity.

Here is a call credit spread idea assuming a double top.



Now the bullish breakout idea,



The trend, slight volatility and futures rollover edge goes to the bull call spread but it has the double top risk so use a close back below 37 as the SU (stop/unwind).

The suggestions above use the closing middle prices between the Friday bid and ask. Monday option prices will be somewhat different due to the time decay over the weekend and any price change.


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It appears rotation out of "growth at any price stocks" along with an oversupply of IPOs, is killing the goose that lays golden eggs. Since the downside momentum is accelerating, expect to see lower lows over the next week or two while watching the S&P 500 Index upward sloping trendline at 1795 for support.


Twitter Follow us on twitter for more ideas from our scanners and other developments.


Actionable 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 run our ranker and scanner tools to find more suggestions.


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.

Next week's issue 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 Website. If you would like to receive the Digest by e-mail let us know at


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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".