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Last week can be summed up by saying there was a noticeable lack of conviction despite several important fundamental developments, including China’s change of policy with respect to the dollar peg, the Swiss National Bank’s decision to let the Swiss franc rise, an agreement on US financial regulation and the G-20 Toronto summit. However, the markets appeared to be indifferent to these developments. We offer some observations and a few strategy comments, but first an update of our indicators.
Market Review S&P 500 Index (SPX) 1076.76. As an one example of uncertainty, the breakout above the small double bottom turned lower last Monday with a key reversal only to be followed with a key reversal up on Friday. The apathy is supported by a meaningful lack of SPDR (SPY) 107.87 volume. Last Monday’s key reversal down volume was on 213 million shares, followed by Friday’s key reversal up volume up on 239 million shares. A more convincing level of volume, in either direction, would have been in the 350-400 million-share range. However, this is summer and volume is usually lighter this time of the year. The lack of volume prompted last week’s Digest Issue 23 where in we expressed doubts about the validity of the falling wedge technical pattern and we remain unconvinced.    E-mini S&P 500 Futures (ESMO) 1074.75. Since the June futures expired, trading volume has been moderate in the 2.2 to 2.5 million contract range with no clear direction indication provided by changing in open interest. For example on Thursday the September futures contract declined 17 points and open interest expanded by 65K contracts suggesting shorting, but on Friday with a 4.25 point increase open interest again increased , this time by 40K contracts. Perhaps it is another sign of summer-time apathy. S&P 500 Index Implied Volatility (IVXM). Since our last review, the Implied Volatility Index Mean decreased from 25.03 to 24.60 while the VIX declined from 28.79 to 28.53. 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 premium to the cash is a SPX sell signal as it indicates professional hedging and the expectation that the cash will rise back toward the futures price. Last week the reading was more bearish at 12.49% compared to 6.77% in our market review two weeks ago. In summary, this indicator is just mildly bearish.  VIX Options With a current Historical Volatility of 159.39, the table below shows the adjusted Implied Volatility (IV) of the at-the-money (27.50) VIX calls and puts based upon Friday closing option mid prices along with their respective month’s futures prices.
VXX Options iPath S&P 500 VIX Short-Term Futures ETN (VXX) 27.72 is based not upon futures but on the cash VXX. The current 20-day Historical Volatility is 64.97 while the 30-day Historical Volatility is 78.83.
The implied volatility readings are very closely aligned with the 20-day Historical Volatility. The VXX is likely to become the preferred hedging tool for many traders focused on volatility as a hedging strategy.   US Dollar Index (DX) 85.31. Although the Swiss Central Bank announced it was no longer supporting the euro against the Swiss franc the euro continued somewhat higher leaving DX below its current upward sloping trendline from the April 80 low. A break below the longer-term trendline at 83 would signal technical trouble for the dollar, while supporting a possible developing Head & Shoulders bottom in the euro. A continuing lower dollar would most likely provide support for equities and commodities.   iShares Barclays 20+ Year Treasury Bond (TLT) 99.05. Reflecting the “risk-off” trade long bond  yields declined to 4.07% from 4.13% in our last review. The 90-day TED spread, our substitute for the often-quoted Libor – OIS spread, now at 40.92 basis points, is again declining from 46.81 bps in our last review. As an interbank liquidity measure, TED’s decline should add more support for equities and other “risk-on” trades. NYSE McClellan Summation Index -44.04. Since out last review, the NYSE Composite Index breadth indicator continued higher recovering 296.52 points, but still in negative territory. The shorter-term oscillator is just below the zero line but now looks to be moving higher. iShares Dow Jones Transportation Average Index (IYT) 76.51. Last week the transports briefly traded back above 80 and the upward sloping trendline, however by the weekend it had rolled over, an apparent casualty of growing doubts about the strength of the global economy. Now a close back above 81 is required for this important indicator to give a green signal.  Baltic Capesize Index 2717. Since our last review, the Baltic dry-bulk shipping rate index for the larger ships carrying iron ore and coal declined another 1559 points reflecting slowing demand from China and indicating further doubts about the strength of the global economy. However, a somewhat lower level of activity could be expected in the summer. Capital Link Tanker Index 2458.43. The tankers declined moderately since out last review and the strength we last saw has waned on a lack of demand on most routes. Once again, summer may be playing a role in the tanker sector, but with expectations of less supply available from the Gulf of Mexico VLCCs rates should be firming.
Strategy The apathetic response to numerous fundamental developments last week could partly be attributed to seasonality, but a more likely explanation is the lack of clear vision for the global economy. Slower economic growth in the US and the many announced cuts in government spending in Europe are rekindling the inflation vs. deflation debate once again and creating hesitation.   Since implied volatilities are not high by recent standards of the past two months, nor low compared to March or April, there is little reason searching for many volatility trades. The markets seem to be suggesting they are half-empty or half full, depending upon ones perspective. Of course, we expect this to change in about two week’s time when the second quarter earnings reports begin.   IVOLopps™ Earnings and Trend Continuation In the meanwhile, here are two companies scheduled to report next week that are in serious down trends suggesting there could be problems with their business models. Apollo Group Inc. (APOL) 43.75. Also known by its brand name, University of Phoenix, APOL provides undergraduate, graduate, and doctoral programs with a for-profit business and marketing model. In Digest Issue 22, we suggested the sale of a June 55/45 call credit spread for a 5.87 credit. At the June expiration, the June 45 call closed in-the-money by 3.39, so the gain would have been reduced by about 3.50 presuming it had been closed before expiration.  Since the stock now appears to be accelerating lower going into earnings scheduled to be reported Wednesday after the close, and does not have any near term support, here is a bearish put spread to consider. The current Historical Volatility is 48.65.
With good edge, the cost of this spread is only 18% of the distance between the strike prices. Use a close back above 45 as the SU (stop/unwind).   Monsanto Co. (MON) 48.27. Here is another stock that recently gapped lower and appears to have no near term support. With a current Historical Volatility of 37.57, consider this bearish put spread.
There is good edge in the short put and the cost is just 24% of the distance between the strike prices. Use a close back above 50 as the SU (stop/unwind).   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 Last week the equity market lacked conviction to move in either direction very far. Most of our indicators suggest the markets are neither overbought nor oversold. Depending upon ones bias, they could be viewed as half-empty or half full. The summer season may be playing a role and we may have to wait for the second quarter’s earnings reports to begin before the situation changes very much.
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In next week’s issue, we will once again offer mostly options trading ideas.

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