The day weighting applied 68% to July and 12% to August as of Friday for a 5.90 % premium shown above. Our alternative volume-weighted average between July and August regularly found in the Options Data Analysis section on our homepage was slightly higher at 6.12%.
Premiums for normal term structures 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 oversold conditions. Last week the volume-weighted premiums started near 20% but ended the week in the cautious zone. 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.
Four Horsemen of the Apocalypse Update
For reference, see Digest Issue 25 "The Four Horsemen of the Apocalypse [Charts]."
Just for clarification, the context for apocalypse is the lesser meaning for an event of great importance rather than the biblical reference to the imminent destruction of the world. From this perspective, it only implies the start of an overdue market correction.
The McClellan Oscillator Summation Index reported by McClellan Financial Publications improved slightly last Monday and Tuesday, but at the week end the final result was a further 25.68 decline thereby increasing the importance of this negative divergence.
iShares Transportation Average (IYT) 147.64 down 3.49 or 2.31% for the week this ETF tracks the important Dow Jones Transportation Average Index measuring the performance of transportation sector US equities and considered a leading economic indicator. According to the widely followed Dow Theory, the transports and the Dow Jones Industrial Average should move in the same direction while divergences signal a possible trend change from a Dow Theory perspective.
After rising up to meet the active downward sloping trendline last Tuesday any chance of a further advance was rebuffed Wednesday after a 3.19 point decline reflecting the 2.9% drop of Union Pacific (UNP) that finally closed the week at 96.77 or 4.34% lower. FedEx (FDX) 173.66 the other sector bellwether fared a bit better declining only 3.49 points or 2.31% for the week. While the strong dollar was recently cited as a reason for FedEx decline, it’s harder to make the same argument for the Union Pacific Railroad.
After downward momentum increased, it needs to close back above 152 to challenge the current downward sloping trendline.
US Dollar Index (DX) 95.47 up 1.40 for the week or 1.49%, with most all of the advance occurring last Tuesday thereby increases the probability that an Elliott Wave five-wave pattern shown in the chart last week may be complete. Based upon seasonal patterns the dollar may continue higher as suggested by Tom McClellan, adding additional headwinds for equities. Since the news over the weekend from Greece to vote on a proposal of reforms that the Greek government rejected as imposing cuts too harsh could result in capital controls along with a global flight to quality favoring the dollar over the euro.
ProShares UltraShort 20+ Year Treasury (TBT) 51.95 our preferred interest rate indicator was up 3.18 points or 6.52% for the week after reversing last Monday to resume trending higher as long-term interest rates advanced from 3.06% to 3.25%. For the last several months long Treasury bonds have sold off going into the nonfarm payroll reports and since the next one is due Thursday it looks like the pattern will repeat although the current trend is higher adding pressure to equities especially interest rate sensitive sectors and companies. However, expectations for higher rates could diminish by concerns for the situation in Greece resulting in a global quality flight back into Treasuries.
As for using ETF options also consider iShares Trust - iShares 20+ Year Treasury Bond ETF (TLT) 115.23 put spreads with good options volume, reasonable bid/ask spreads and some volatility edge as well.
High IV/HV Ratios
In the Rankers and Scanners section of our home page, we offer the “Top 5 stocks by implied volatility change” as regular feature. Of the four categories included, the high IV/HV ratio is the first alert that something unusual is happening since options prices are being bid up to abnormal levels. From there a little more investigation will usually provide clues as to the reason.
Friday two small capitalization biotechs were at the top of the list.
First was XOMA Ltd. (XOMA) 3.92 with an implied volatility of 219.28 and a historical volatility of 48.43 for an IV/HV ratio of 4.53, market capitalization 462 million.
In second was Exelixis Inc. (EXEL) 3.77, implied volatility 178.19 and historical volatility of 51.51 for an IV/HV ratio of 3.46, market capitalization 739 million.
Both are in the red-hot biotech sector that some say is in bubble territory, but recent takeover activity has drawn attention to even small companies that may develop new treatments.
IV/HV ratios in excess of 2.50 usually means the potential for a price move is greater than implied by the option prices especially for low priced small capitalization stocks. In this case, the high implied volatility most likely suggests takeover speculation more than drug announcement news, the usual force underlying high implied volatility in the biotech and pharmacy sectors.
The combination of small capitalization and low stock price often translates into low option volume and wide bid/ask prices and these two are not exceptions, while both traded more than 20K option contracts Friday the bid/ask spreads were so wide they precluded using spreads, with one credit spread exception.
Exelixis expects to make two announcements, one sometime in July, and the other before August 11.