« September 2010 »

IVolatility Trading Digest™

Volume 10, Issue 36
Yen for Gold

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Yen for Gold

Not only is yen the currency of Japan it is also an expression of desire, craving and yearning. Last week the yearning for gold was clear as Japan sold yen for dollars in an effort to support their export economy. However, not everybody can depreciate their currency at the same time without creating inflation in tangible currency alternatives such as gold, silver, wheat and corn. The Japanese intervention made an unequivocal statement that competitive devaluation is the name of the game. If the Chinese refuse to let their currency appreciate and increase imports, the tangible alternatives to currencies will be pushed even higher. In this Digest, we review our market indicators and then offer an option strategy idea for the precious metals uptrend.


Market Review

S&P 500 Index (SPX) 1125.59. In our last market review in Digest Issue 34, we looked at the active Head & Shoulders Top and concluded as long as it remains above the July 1 low of 1011.40; the most likely outcome is for a trading range between 1025 and 1125. Now at the upper end of that range estimate, it is now likely to turn lower once again since the September futures and options have expired. New alternatives will be considered in the unlikely event it continues working its way higher.

E-mini S&P 500 Futures (ESZ0) 1119.75. The September futures contracts expired Friday without providing any information about the continuous matching of supply and demand between the longs, shorts and the most important hedgers. At the peak of the rollover surge on Wednesday, total open interest was almost unchanged at 3.498 million compared to 3.515 in June.

S&P 500 Index Implied Volatility (IVXM). Since our last review, the Implied Volatility Index Mean increased slightly from 18.12 to 18.79, but there is significant skew with the calls at 17.33 while the puts are 20.25. The VIX increased from 21.31 to 22.01.  

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.

VIX Cash


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 20.99%, compared to 23.71% in our market review two weeks ago. Currently in the mid teens, this indicator is about neutral.

VIX Options

With a current Historical Volatility of 90.25, 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.


VIX Options


VXX Options

iPath S&P 500 VIX Short-Term Futures ETN (VXX) 17.16, is based on the cash VIX not the futures. The current 20-day Historical Volatility is 44.17 down from 56.04 in our last review, while the 30-day Historical Volatility is 49.02 down from 49.69 in the last review two weeks ago.


iPath S&P 500 VIX Short-Term Futures ETN (VXX)


The Implied Volatility Index Mean is 66.06 with the calls at 67.35 and the puts at 64.78 a noticeable skew to the calls. Although the put-call ratio is .75 options traders appear biased to the upside expecting, and/or hedging an increasing VXX corresponding with a declining S&P 500 Index.

US Dollar Index (DX) 81.40. After the August vacation period, a new short-term trend did emerge and it was to the downside. We expect it will continue lower to test the previous support in the 80 range providing more justification for long equities and most of all commodities.

CurrencyShares Euro Trust (FXE) 129.88. Now near the upper end of the current range between 125 and 132 FXE looks like it will have difficulty moving much higher as FX traders shifted their attention to the Japanese yen.   

iShares Barclays 20+ Year Treasury Bond (TLT) 101.67. Long bonds continued lower creating a defined downtrend with the potential to continue down to support at 97.50 or a yield of about 4.13% up from the low of 3.46% on August 25 influenced by the long bond/ short equity trades over the holiday period when markets were thinner than usual.

The 90-day TED spread our substitute for the often-quoted Libor – OIS spread, is now 14.45, having declined another 2.36 basis points since our last review. As an interbank liquidity measure, TED's decline back into a more normal range confirms the improved interbank lending environment adding some support for "risk on" trades and new bond offerings. 

NYSE McClellan Summation Index 695.76. Since our last review, the NYSE Composite Index breadth indicator increased 319.53 points taking it back up near its previous pivot just above 750. Unless the S&P 500 Index can continue above the current range boundary of 1125, this indicator is near another inflection point and is likely to turn down once again as equities indices roll over and head back toward the lower end of their ranges once again. 

iShares Dow Jones Transportation Average Index (IYT) 80.33. Although the upper end of the trading range is 82.50 IYT is struggling here at 80 and looks like it is about to roll over and head lower. This would most likely be consistent with the decline of the S&P 500 Index from the top of its range boundary.  

Ocean Shipping Indices. Since the ocean freight indices are now being depressed by the arrival of numerous new ships, adding unusually large amounts of supply they are no longer reflecting changes in shipping demand. As a result, they have lost their value in forecasting global economic activity. Until there is a dramatic change in the supply situation, we are suspending the ocean shipping indices from our market review.


For those who sold yen for gold early in the week the gains were substantial. The chart below shows the gold continuous contract priced in yen and the rise that began last Wednesday.


the gold continuous contract priced in yen

Last week the story was about Japan selling yen to buy dollars as they increased their money supply in an effort to reduce the yen exchange rate to support their exports. Competitive devaluations are now a real concern for the global economy and could accelerate the buying of commodities and tangible assets.

Since an equity decline is expected we suggest unwinding or closing any long call spreads that may still open such as the one suggested in Digest Issue 33



Although both gold and silver appear to be overbought and due for a correction the actions taken in the currency markets last week by Japan changed the picture. Now the risk has been shifted to the upside for those who are not yet in these markets. Using options, a position can be created to participate in any further advance while limiting the correction risk. Consider this silver idea.

iShares Silver Trust (SLV) 20.29.

With a Historical Volatility of 18.54 and an Implied Volatility Index Mean of 29.33 for an IV/HV ratio of 1.58 and a very bullish put-call ratio of .24 consider this combination.


iShares Silver Trust (SLV) 20.29.


In the event there is a correction in the next few weeks, there is a chance the Oct 20 put will be in the money and assigned. This could be part of a plan to establish a long ETF position. In the event there is no near pull back then the October will expire reducing the cost on the outstanding long call spread. However, if the correction continues back below 19, then consider unwinding.    

As an alternative, here is another idea using the December 20 put. This one allows enough time for the expected correction to be completed before the options expire, but has enough time to go right into the peak of the seasonal strength.


iShares Silver Trust (SLV) 20.29.


This position is the equivalent of an 82 share long position for a credit although there is a margin requirement of $669.80 in a standard margin account, for both the long call spread, the first two legs in the table above and the short put, the third leg.

Use a close back below 19 as the SU (stop/unwind). Compared to the Historical Volatility both of the legs sold offer some implied volatility edge.

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.



Since the S&P 500 Index is now at the top of its range changes are good that a correction will be starting within the next week taking it back down toward the lower end of the range near 1025.

In the meanwhile, commodities and precious metals are likely to remain relatively strong.


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In next week’s issue, we will again check our rankers and scanners to find more options trading ideas especially if the expected equities correction begins.


Takeover File Update


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.

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Are SLV December options currently available to trade? I'm only seeing Oct, Nov, Jan 2011, April 2011, Jan 2012, and Jan 2013 options available.

What am I missing?

Posted by Tyler Craig on September 23, 2010 at 02:30 PM EDT
Website: http://tylerstrading.blogspot.com


Thanks for the comment. You are right; we were looking at the January options, but wrote December. Sorry for the confusion.


Posted by Jacktrader ( on September 27, 2010 at 06:21 PM EDT

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IVolatility Trading DigestTM Disclaimer
IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter constitutes a recommendation to buy or sell any security. Before entering a position check to see how prices compare to those used in the digest, as the prices are likely to change on the next trading day. Our personnel or independent contractors may own positions and/or trade in the securities mentioned. We are not compensated in any way for publishing information about companies in the digest. Make sure to due your fundamental and technical analysis homework along with a realistic evaluation of position size before considering a commitment.

Our purpose is to offer some ideas that will help you make money using IVolatility. We will also use some other tools that are easily available with an Internet connection. Not a lot of complicated math formulas but good trade management. In addition to Volatility we use fundamental and technical analysis tools to increase the probability of success and reduce risk. We prepare a written trade plan defining why the trade is being made, what we call the "DR" (determining rationale) and the Stop/unwind, called the "SU".