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From the prior week's "Risk Off" last week it was "Risk On" once again with an oversold rally taking the S&P 500 Index 5.4% higher. Now traders and investors want to know if the bottom has been made, or should we expect to see lower lows? In an effort to answer this question, we will review our indicators and offer a strategy suggestion.
Market Review S&P 500 Index (SPX) 1077.96. After a substantial rally that took the index past the overhead resistance at 1040.78 look for a minor trend change indicator for clues that this run could be about over. A downward sloping trendline extended from the April 26 high at 1219.80 to the June 21 high at 1131.23 makes a good upper boundary that should contain the current upmove in the 1088-1090 range. If so, then the large Head & Shoulders Top described in last week’s Digest Issue 26 continues to be the operative technical pattern with a downside-measuring objective at 862.  One reason for concluding there is more downside to come has to do with the light volume of this most recent rally off the July 1 low at 1011.40. The Tuesday turn around volume of the SPDR (SPY) 107.96 was 257 million shares and then it declined every day ending at only 143 million on Friday. The fact it was a holiday shortened summer week could account for the low volume and could be the reason rally was not turned back at the 1040.78 resistance level. E-mini S&P 500 Futures (ESMO) 1072.50. Unlike the cash, the E-mini made a key reversal on Tuesday closing ten points higher as open interest expanded 39K contracts. For the rest of the week open interest declined on the continuing price increase suggesting some shorts were closing positions, probably at a loss. Volume was moderate every day except Friday.    S&P 500 Index Implied Volatility (IVXM). Since our last review, the Implied Volatility Index Mean decreased from 24.60 to 22.08, while the VIX declined from 28.53 to 24.98. 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 8.74%, compared to 4.87% in our market review two weeks ago. In summary, the VIX Futures indicator is becoming more bearish.  VIX Options With a current Historical Volatility of 133.85, the table below shows the adjusted Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon the closing option mid prices on Friday along with their respective month's futures prices.
VXX Options iPath S&P 500 VIX Short-Term Futures ETN (VXX) 25.55 is based not upon futures but on the cash VIX. The current 20-day Historical Volatility is 60.66 up from 50.06 last week, while the 30-day Historical Volatility is 69.52 up from 67.13 last week.
The Implied Volatility Index Mean at 75.49 is up from 65.46 last week and there is a noticeable skew between the calls at 77.42 up from 66.37 last week and the puts at 73.55 up from 64.54 last week. Using the 20-day Historical Volatility there is a positive volatility spread that appears to be increasing as the calls are bid higher by hedgers expecting the S&P 500 Index to decline accompanied by an increasing VIX.   US Dollar Index (DX) 83.95. Although the Swiss National Bank said it is no longer supporting the euro against the Swiss franc, the euro continues moving higher after having made a Head & Shoulders Bottom. Using the CurrencyShares Euro Trust (FXE) 126.00, our estimate of the minimum upside measuring objective for the euro is 129.64. We wonder if the euro support is now coming from China. Based on recent correlations the stronger euro and the correspondingly lower dollar would most likely provide support for equities and commodities.   iShares Barclays 20+ Year Treasury Bond (TLT) 99.22. As a “risk-on” indicator, long bond yields are back to 4.04%, having declined as low as 3.86% on July 1. The 90-day TED spread, our substitute for the often-quoted Libor – OIS spread, is now at 38.18 basis points down from 40.92 basis points in our last review. As an interbank liquidity measure, TED’s decline should continue adding support for equities and other “risk-on” trades. NYSE McClellan Summation Index -215.66. Since out last review, the NYSE Composite Index breadth indicator reversed to the downside with a 171.62-point loss and the shorter-term oscillator is approaching overbought territory, not a positive development for the bullish case iShares Dow Jones Transportation Average Index (IYT) 75.16. After declining as low as 70, IYT recovered with the rally, however a close back above 82 ½ is now required for this important indicator to signal that the market uptrend has resumed. Baltic Capesize Index 2102. Since our last review, the Baltic dry-bulk shipping rate index for the larger ships carrying iron ore and coal declined another 615 points reflecting slowing demand from China and new ship deliveries along with storage contract terminations. On a more positive note, the World Shipping Council says that May container shipping volumes on the key Asia-Europe route rose 20.9%. Capital Link Tanker Index 2311.13. Since our last review the tankers index declined moderately, but in the VLCC sector, benchmark rates have hit their lowest level of the year. For example, the 270’ MEG-Korea rate declined from $55,686 per day to $19,308 per day. According to PF Bassoe, the Norwegian shipbrokers, "Tonnage that has been doing floating storage has begun to redeliver, adding to the pressure on spot rates." This redelivery of tonnage is understandable since the 3-month crude oil contango has declined from $7.18 per barrel in mid May to just $1.56 last week.
Strategy Going into options expiration at the end of the week the noticeable lack of trading volume, typical for this time of year, is adding some additional uncertainty to the market analysis. Based upon S&P 500 Index the operative technical analysis pattern is the Head & Shoulder Top with a minimum measuring objective down at 862. Watch the 1088 to 1090 level for signs of a minor trend change indicator to increase hedging or short positions. The lack of breadth participation and the lagging transports supports the Head & Shoulders Top view with the expectation that of the low of 1011.40 made on July 1 will be exceeded on the downside. Last week in Digest Issue 26 we expressed skepticism in what appeared to be an effort to push down stock prices before the second quarter earnings reports that are scheduled to begin this week. This doubt was formed in part by looking at the price action last year as the S&P 500 Index declined 17 points in the first week of July and then gained 61 points in the second week after the earning reports began. While no two years are exactly alike, a seasonal pattern should be considered. This alternative argument, that the bottom for the year has been made, is supported by numerous double bottom patterns in selected leading individual stocks.
With the important technical Head & Shoulders pattern is showing a topping formation it is conflicted by the seasonal tendency for prices to rise going into earnings reports. We suggest one strategy is to apply some patience and wait to see how it is resolved. Further, since implied volatility is in a mid range, the advantage to selling option premium, or buying inexpensive options, is not compelling. The directional answer will most likely be revealed as the S&P 500 Index approaches 1088 to 1090 in the next few days.   Summary At this point, the best answer to the "risk-on" question is maybe. While our indictors reflecting economic conditions are not supportive for higher equity prices, second quarter earnings reports will begin this week so understandably the equity market is reflecting caution while waiting for more data.
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In next week’s issue, we will return with specific options suggestions based primarily upon second quarter earnings reports.

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.

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