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Once again, the pendulum swung back to the "risk on" position despite the uncertainties created by the unresolved macro debate over deficit cutting or more stimulus and coming changes to the financial system from "Fin Reg". In addition, to the fundamental uncertainty the same can be said about the technical outlook. In this Digest, we mull over our market indicators and offer one long idea.
Market Review S&P 500 Index (SPX) 1102.66. Last Tuesday’s reversal to the upside started a minor trend that continued above the 1088 – 1090 expected range and above the downward slopping trendline that had been defining the upper boundary. As a result, some doubt has been created about the continuing validity of the large Head & Shoulders Top described in Digest Issue 26 with a downside-measuring objective at 862. Watch the July 13 high at 1099.46, which is now support, for the next clue. If the support holds, it will add further doubt about the Head & Shoulders Top. If it fails however, then SPX will have defined a new right shoulder high increasing the probability of reaching the previously defined downside measuring objectives at considerably lower levels. E-mini S&P 500 Futures (ESMO) 1100.50. Last week’s volume for the e-mini was moderate, in the 2 million-contract range, while Thursday’s decline in open interest of 15,092 contracts when the price moved higher by 23.75 points, suggests the possibility short sellers were being squeezed and closing positions, probably at a loss. S&P 500 Index Implied Volatility (IVXM). Since our last review, the Implied Volatility Index Mean declined from 22.08 to 20.87, while the VIX declined from 24.98 to 23.47. 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 indicating professional hedging activity and the expectation that the cash will rise back toward the futures price. Last week the reading was 15.81%, compared to 13.49% in our market review two weeks ago. In summary, the VIX Futures indicator continues to signal a moderately bearish probability.    VIX Options With a current Historical Volatility of 94.45, 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) 23.65 is based on the cash VIX not the futures. The current 20-day Historical Volatility is 61.20 down from 61.29 last week, while the 30-day Historical Volatility is 58.80 down from 65.13 last week.
The Implied Volatility Index Mean at 60.34 is down from 79.78 last week. The skew has reversed with the calls at 59.47 and the puts at 61.22. Options traders now appear biased to the downside expecting the S&P 500 Index to continue increasing accompanied by a declining VIX.   US Dollar Index (DX) 82.46. The dollar index has clearly broken the long- term uptrend that began last November due to the strength of the euro after it made a Head & Shoulders Bottom. Using the CurrencyShares Euro Trust (FXE) 128.72, our estimate of the minimum upside measuring objective is 129.64, with resistance at 132.50. Now since the European bank stress tests are complete and China has publicly expressed support for the euro, we expect it will soon reach resistance and if the previous correlations hold any further increase should provide support for equities and commodities. iShares Barclays 20+ Year Treasury Bond (TLT) 99.78. As a "risk-on" indicator, long bond yields are now 4.01%, 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 34.81, and since our last review has declined another 3.37 basis points. As an interbank liquidity measure, TED's decline should add support for equities and other "risk-on" trades. NYSE McClellan Summation Index 219.77. Since our last review, the NYSE Composite Index breadth indicator turned positive crossing back above the important zero line, although the shorter-term oscillator is approaching overbought territory as the upward momentum increased last week. The rise back above zero provides important support for the bulls. iShares Dow Jones Transportation Average Index (IYT) 78.80. Adding more support for the bulls IYT now is trending higher although it needs to cross back above 83 to be back above the long- term trend line from the March 2009 low. Baltic Capesize Index 1708. Since our last review, the Baltic dry-bulk shipping rate index for the larger ships carrying iron ore and coal continuing declining at slower pace, this time down 394 points, as analysts continue to cite new ship deliveries as one important factor. However, according to PIERS Global Intelligence Solutions, The Port of Los Angeles had the most container traffic in its history surpassing the number of container ships moving through the area during the economic boom. Capital Link Tanker Index 2419.90. Since our last review, the tanker index increased moderately, up 108.77, and the VLCC sector appears to have stabilized at the current lower level, as storage is no longer a part of the pricing equation since the crude oil futures 3-month roll has declined to $1.22 per barrel.
Strategy In this environment of "risk on", one week, followed by "risk off", the next, the likelihood of being whipsawed has greatly increased. The challenge is further complicated by the high correlation between commodities and equities as they rise and fall together seemingly without much logical justification. Even with the increased whipsaw risk, perhaps the best strategy is to reduce the trade size and carefully trade just what you see and not what you may think. Following this line of thought here is what one well-known veteran trader says about it. "Don't believe anyone's opinion in the markets. No, not even your own. Learn to trade from the reality of what you see, and that is it. There is nothing else. Trade clear cut signals from your technicals if you must, but have no opinion concerning them. Just trade what you see." Joe Ross Since the major indices are not trending following the technicals has resulted in being whipsawed over the past few weeks and this is the reason to reduce the trade size and to continue carefully trading what you see using trade plans that include stop loss limits. IVOLopps™ Last week Digest Issue 28 was in "risk off" mode and the subsequent "risk on" again market action required careful attention to the predetermined stop or unwind limits. Now it is carefully back to the long side once again.     SPDRs (SPY) 110.41. With a current Historical Volatility of 21.50 and an Implied Volatility Index Mean of 21.26, consider this bull call spread idea.
Using the high made on July 13 at 110.09 as the new support level, we suggest closing this position if it closes below this level. In the event it should close below it on Monday then we do not suggest making the trade. Due to the recent whipsaw market conditions and since there is no edge, and since this is a directional trade, we suggest using an out-of-the-money spread with a relative low delta as shown above at .2245. In addition, we suggest using September to allow enough time for more whipsaw activity and to reduce the time decay.   With respect to risk management keep the position size small and close or unwind it on a close back below 110.09. The suggestion above is 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 Fundamentally the markets are reflecting uncertainty which creates instability therefore they are prone to whipsaw, "risk on" one week followed by "risk off" the next as the pendulum swings from one side to the other. One strategy for this predicament is to reduce position size and trade based upon the technicals without trying to understand how the conflicted fundamentals may be influencing the markets.
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Next week we will be on vacation and as they say in show business, the stage will be dark. We will return with another market review and update on August 9.

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