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IVolatility Trading Digest™ Blog
Monday March 03, 2014
Volume 14, Issue 9
Index Disharmony - IVolatility Trading Digest™
Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Without any help from the weather, after several anxious weeks, without fanfare the S&P 500 Index finally broke out above the seemingly impenetrable barrier at 1850.84, putting an end to concerns about a potential Head & Shoulder Top pattern we have been carefully following. This should mean all is clear for the uptrend to resume. However, index divergences are suggesting the need for further investigation. While adding our other indicators to the mix helps a little to make the bull case, we remain somewhat cautious.
We begin with our market review.
S&P 500 Index (SPX) 1859.45. Last week in Digest Issue 8 "Could Go Either Way", we acknowledged the diminishing probability the missing right shoulder would form keeping in mind it continued to be a possibility until it exceeded the head at 1850.84 on a closing basis, which occurred last Thursday on rather low unimpressive volume. It continued higher Friday with more convincing volume, which helped confirm the breakout.
However, when we look at the SPDR Dow Jones Industrial Average (DIA) 163.03 we still see a potential Head & Shoulders Top that would requiring a close back above the December 31, 2013 high of 165.51 to resolve the divergence. Perhaps the Dow Jones Industrial Average is no longer the best market measure since non-industrials like Coca-Cola (KO) 38.20, UnitedHealth Group (UNH) 77.27 and others have replaced many of the industrial issues over the years. In addition, the Dow Jones Transportation Average, detailed below adds to the divergence concerns.
On the positive side, Power Shares QQQ (QQQ) 90.34 broke out above the previous January 22, 2014 high of 89.00 on February 13, 2014 and then made eleven consecutive closes above 89.00. Maybe we should be paying more attention to this index and not be overly concerned about the lagging Dow Jones Industrials and Transports.
CBOE Volatility Index® (VIX) 14.00. The VIX now seems to favor the 14 level like this is the new normal compared to last year when it often declined to 12.
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 55% to March and 45% to April for an average premium of 10.38% shown above. Our alternative volume-weighted average between March and April, regularly found in the Options Data Analysis section on our homepage, is slightly lower at 10.12%. We said in Digest Issue 7 "Right Shoulder Appraisal", the premium should be back into a 10% - 20% range when the S&P 500 Index closes above 1850.84.
With a current 30-day Historical Volatility of 133.44 and 82.54 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 average implied volatility of the four at-the-money VIX options at 76.22 compared to the range historical volatility of 82.54 suggests they are relatively inexpensive and not reflecting much concern about an immediate SPX decline.
CBOE S&P 500 Skew Index (SKEW) 137.16. 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.
Now 6.22 above the midpoint of the current relevant range between the November 6 low of 118.69 and the December 20 high of 143.19, it reflects increased hedging activity with out-of-the-money puts as the S&P 500 Index moves into new high territory.
US Dollar Index (DX) 79.69. For the last week or so, it seemed to find support around 80 but then made an unexpected decline Friday closing right on the December 27, 2013 low at 79.69. It's unclear if comments made by Federal Reserve Chair Janet Yellen, that the central bank may change its strategy for reducing asset purchases should the economy weaken, was the reason for Euro strength and dollar weakness.
10-Year Treasury Notes (TNX) yield 2.65% after reaching 3.03 on December 31. After reaching an intra-day high of 2.78 on February 21, interest rates declined all last week as seasonal factors and the weather continue to be cited as reasons for slowing economic conditions, which is consistent with the weaker dollar.
iShares Dow Jones Transportation Average Index (IYT) 131.74. The transports are in a narrow range around 130 and unable to make much progress after the gap lower on January 24. It would take a close back above the January 23 high at 135.93 to confirm the S&P 500 Index breakout. In the meanwhile, this creates a negative Dow Theory divergence to consider along with the lagging Dow Jones Industrial index. Both seem to be reflecting expectations for a slowing economy and confirmed by decelerating rail traffic.
NYSE McClellan Summation Index 924.37. 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 Your Stock Exchange. The summation index is neutral at the +1000 level and it generally moves between 0 and 2000. However, it has been continually below the peak of 1218.52 made May 21, 2013 as the market continued higher creating a divergence. Since our last review in Digest Issue 7 "Right Shoulder Appraisal", it advanced 398.33 points as the NYSE Composite confirmed the new S&P 500 Index high.
While not suggesting additional hedging, we are also not suggesting now is the time to load the boat with new longs. Until the index divergences are resolved, we suggest continued caution remains sensible. Neither the VIX Futures premium nor the VIX options reflect concerns of an immediate decline and the market breadth continues to improve but the transports suggest economic slowing that may be more than the weather related. In addition, any unexpected macro event could quickly change the short-term outlook from neutral to negative.
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While a potential S&P 500 Index Head & Shoulder Top is no longer active after closes above 1850.84, the same is not true for the widely followed Dow Jones Industrial Index that remains vulnerable in the event of any market decline since it would create a missing right shoulder setting the stage for a more serious decline. In addition, the lagging Dow Jones Transportation Index suggests economic weakness that may extend beyond the weather. For now, we remain somewhat cautious.
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We now offer trading ideas from our RT Options Scanner every day in the News section of our home page about two hours before the close based upon active calls and puts with increasing implied volatility and volume.
In next week's issue, we will again fire up the rankers and scanners to find more 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.
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