Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

Although European sovereign debt still occupies a large portion of the financial news space there is little doubt that the crude oil bellowing up from the bottom of the Gulf of Mexico is about to take top billing on the list of economic concerns. Like the inverse of decaying option time premium, every day the rupture spews more crude oil, the risk of permanent supply disruption due to political exasperation increases exponentially. In the meanwhile, we offer our Market Review along with some strategy ideas and one volatility trade suggestion.
Market Review S&P 500 Index (SPX) 1089.41. Since our last market review, the nature of the consolidation pattern in the form of a right triangle or perhaps a bearish rising wedge has evolved into a bullish falling wedge or perhaps a new developing Head & Shoulders Top. In the Strategy section below, we explore these technical developments in detail with an updated weekly chart. E-mini S&P 500 Futures (ESM0) 1088.50. A large increase in open interest on days when the contract closes lower is a sign the shorts are pressing their bets. For example last Monday when the contract was 13.50 lower, open interest increased by 48K, then again on Wednesday when it closed 11.75 lower, open interest increased another 40K , but on Thursday with a 39.75 point advance, open interest only declined by 30K, confirming the bears are still controlling this market. S&P 500 Index Implied Volatility (IVXM). Since our last review based upon May 14 data the Implied Volatility Index Mean increased from 25.39 to 27.24 and the VIX increased from 31.24 to 32.07, after retreating from a May 21 high of 48.20.     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.
For this short-term indicator the discount to the cash is a buy signal indicating the degree of professional hedging. This week at -4.08 is lower than last week at -10.87 and compares to -7.54 in our last review. The continuing discount suggests another up move is expected.  The differential between the VIX cash at 32.07 and the 20-day Historical Volatility of the SPX at 32.05 has almost disappeared as the VIX spiked and then declined while the Historical Volatility continued to rise. The previous 227% differential recorded on Apr 1 shown in the table below was a leading indicator suggesting Historical Volatility would be increasing.
VIX Options With a current Historical Volatility of 227.90, the table below shows the adjusted Implied Volatility (IV) of the at-the-money (32.50) VIX calls and puts based upon Friday closing option mid prices along with the respective month’s futures prices.
US Dollar Index (DX) 86.48. DX appears to be stalled at the 87 level corresponding to an oversold euro at 121-122. Traders are likely looking for a bounce in the euro as an opportunity to establish new shorts, as the sentiment remains bearish. The current inverse correlation with equities suggests any DX decline with a euro rally will be accompanied by an equity rally. iShares Barclays 20+ Year Treasury Bond (TLT) 96.50. Long bonds retreated somewhat as the yield increased to 4.21%. The 90 day TED spread, our substitute for the often quoted Libor – OIS spread is now 38.11 basis points up from 30 bps in our last review and still a long way from the 463.62 basis points peak on October 10, 2008, as we noted in Digest Issue 18. NYSE McClellan Summation Index -230.49. Since out last review, the NYSE Composite Index breadth indicator declined 772.88 points, descending into negative territory providing another argument that the current decline is more than a bull market correction.  iShares Dow Jones Transportation Average Index (IYT) 78.47. The transports crossed and closed below the upward sloping trendline on Tuesday when it closed at 71.76, but recovered on Wednesday and then closed back above 77 and above the trendline once again. This important confirming indicator should be closely followed. Another decline below the long-term trendline would add support for the bear case.    Baltic Capesize Index 5217. Since our last review, the Baltic dry-bulk shipping rate index for the larger ships that carry iron ore and coal advanced another 413 points. This indicator is not reflecting any current weakness. Capital Link Tanker Index 2330.31. The tankers declined another 85.74 since out last review and there were no further comments seen about VLCC charter inquiries for use as crude oil storage. For now, tankers are not sharing the same optimism seen in the dry-bulk sector.
Strategy The updated weekly chart of the S&P 500 Index below shows both a developing falling wedge outlined in green and the location of a potential right shoulder (RS) of a possible developing Head & Shoulders Top.
A close above the upper green line forming the bullish falling wedge would activate this pattern taking it back up toward the upward sloping trendline. A higher close than the left shoulder (LS) at 1150.45 would put the formation of the right shoulder (RS) in doubt. In order to resume the uptrend from the March 2009 low it would then need to close back above the upward sloping trendline. In the event it turns lower in the area of the right shoulder and then closes below the neckline (not shown) at 1040, it would activate the bearish pattern with a minimum measuring objective at 861.76 shown as MO above. Alternatively, it would take a close back above the Head at 1219.80 to negate the potential Head & Shoulders Top and a resumption of the long-term uptrend.   IVOLopps™ Relative Strength The deepwater drilling moratorium in the Gulf of Mexico has taken a toll on the oil service industry with significant gulf operations. On Friday, there were a few exceptions in the sector.  Nabors Industries Ltd. (NBR) 19.03. NBR is known as primarily as an international land drilling contractor. Investors appear to be differentiating between offshore and land based oil and gas companies. Here are a few more land operators showing relative strength on Friday. Helmerich & Payne Inc. (HP) 37.68 Patterson-UTI Energy Inc. (PTEN) 14.03 SandRidge Energy, Inc. (SD) 6.44 Permian Basin Royalty Trust (PBT) 17.85 Encore Energy Partners LP (ENP) 15.52 While all of the above have listed options they are not a liquid as some other better know companies so the bid/ask spreads will be wider. We suggest using spreads such as bull calls and call ratio back spreads with defined and limited risk levels. In addition, set the SU (stop/unwind) levels when the positions are opened using closes below the most recent pivots.     Volatility Idea Interactive Brokers Group Inc. (IBKR) 16.77 IB operates as an automated global electronic market maker and broker engaged in routing orders, and executing and processing trades in securities, futures, and foreign exchange instruments on approximately 80 electronic exchanges and trading venues worldwide. Fundamental to its role as an options market maker they generally carry a long volatility position enabling them to supply liquidity in both up and down markets, as they are sellers in up markets and buyers in down markets. With a net long volatility position, they should benefit from the higher volatility experienced in the second quarter. Their next earning report is scheduled for July 22 and chances are this potential improvement is not reflected in the current earnings estimate of .16 per share. With a current Historical Volatility of 28.78 and an Implied Volatility Mean Index of 27.05, consider this call ratio backspread with long vega from the extra long call.
Based upon Friday’s mid price each September 17 ? were .90 each or 1.80 as shown above. Since the bid/ask spread are wide be prepared to pay more which will reduce the indicated credit. With an extra long call, the position will benefit if volatility rises. Use a close below the last pivot at 16 as the SU (stop/unwind). Since the options are not actively traded, especially in September, sell one of the 17 ? calls. If the stock continues lower, sell the other long call converting the position into a net short call. All of the suggestions above are based upon last Friday’s closing prices using the mid price between the bid and ask. On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.   Summary Most indicators are negative consistent with the negative fundamentals from Europe and the Gulf of Mexico. While the S&P 500 Index now appears to be oversold, any rise faces technical resistance from the previous highs and a potential Head & Shoulder Top that could produce a much more serious decline.
IVolatility.com Bookstore. In addition to the vast number of articles on our web site, take a browse through our bookstore for more reference information and material.
Follow us on twitter for more ideas from our scanners and other developments
In next week’s issue, we will update the progress of the S&P 500 Index and offer more specific options trading 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. 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.