« March 2017 »

IVolatility Trading Digest™

Volume 17 Issue 11
Consider Planting Hedges [Charts]

Consider Planting Hedges [Charts] - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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In a classical "Buy buy the rumor sell the news" manner interest rates advanced and equities declined last week right into the nonfarm payroll report Friday and then reversed. Now expectations are high for an announcement after the FOMC meeting Wednesday that interest rates will increase and there is some evidence markets are preparing for the possibility the Fed is planning to announce that rates could increase at a faster pace than previously anticipated. While this may be another "Buy the rumor sell the news" event, some investigation may be worthwhile. After brief market update and reviewing some indicators, we include our take on crude oil from the perspective of the latest Commitments of Traders report and then suggest joining the hedgers with a SPDR S&P 500 ETF (SPY) put spread idea.

Review NotesS&P 500 Index (SPX) 2372.60 declined 10.52 points or -.44% for the week dropping down to 2350 and finding support after filling the previous gap above 2370, and then turning higher Friday. The next support is down at 2300 and then 2275 going all the way back to December 13. The upward sloping trendline, USTL from the November 4 low now crosses at 2350 and remains the key level to watch in the event of a further pullback. See Digest Issue 9 "Rotation Alert [Charts]" for a chart of the current upward sloping trendline.

VIXCBOE Volatility Index® (VIX) 11.66 advanced .70 or +6.39 % for the week while the comparable IVolatility implied volatility index mean, IVXM 8.86 rose .29 or +3.38% reflecting last week’s modest pullback before Friday’s nonfarm payroll report.

VIX Futures Premium

The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second months.

With 7 trading days until the March expiration, the day- weighted premium between March and April allocated 28% to March and 72% to April for a 17.77% premium reflecting a higher VIX along with less time to expiration for the March futures.


Week ending March 3, the premium was well into the comfort zone at 25.36% and now with just 7 trading days to March futures expiration, any further VIX advance will put the premium in the caution zone.

Hedge Indicators

HedgeIndicatorsRevealing some concerns for the bulls.

First market breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that factors out the number of issues traded, and reported by McClellan Financial Publications, declined 328.90 points for the week closing at 439.94 and closing below the 50-day moving average at 658.68. Although similar previous declines have led the major index declines, the timing could be from weeks to months. For example, after the last down crossover on August 18 it continued lower for three more months before turning higher after the Presidential election. During the entire time, SPX was trending just slightly lower. While a caution sign and not a precise timing tool, it does reflect more issues are declining than advancing.

Next the S&P 500 Index (SPX) put open interest has been trending higher again reflecting more hedging activity. While put open interest always exceeds call open interest, spikes higher correspond with periods of increased uncertainty like now before Wednesday’s FOMC meeting.


With total open interest in excess of 16 million contracts, more than 10 million are puts, but high ratios are often contrary signals.

Finally, here is a chart for the total open interest of options on VIX futures; another indicator that can be a contrary sign, it reveals there is a lot of hedging with VIX going on.


With a weekly average open interest of 10.4 million contracts, it’s at the highest level since we have been tracking it.

Crude Oil COT Update

Crude OilWTI Light Sweet Crude Oil (CL) 48.49 basis April futures dropped dramatically last Wednesday and then continued lower Thursday and Friday to end the week down 4.84 points or -9.09% lower.

The story begins with the Disaggregated Commitments of Traders - Options and Futures Combined report as of February 28. "Managed Money" the group that best correlates with crude oil price changes and arguably the most important, decreased their long position by -17,555 contracts while increasing shorts -9,375 for a net change of -26,930 contracts representing 13.99% of the open interest, down from 15.16% as of February 21.

Then last Tuesday from the CERAWeek energy conference in Houston, Saudi Energy Minister Khalid al-Falih said fundamentals are improving only because Saudi Arabia cut beyond what it pledged in November bringing its production below 10M bbl/day and it was premature to consider extending cuts into the second half of the year. Adding, any decision to extend the agreement would depend on how quickly oil inventories decline to average levels as well as compliance by other producers. This comment, along with other bearish comments from CERAWeek focused the market on Wednesday’s EIA inventory report showing a greater than expected inventory gain of 8.2 million barrels vs. 1.97 million barrels expected. WTI promptly declined 2.86 points or -5.38%.

The combination of "Managed Money" selling, commentary from CERAWeek in Houston and a greater than expected inventory build set off a stampede for the exit.

Then Friday the latest Commitment of Traders Report as of March 7 showed “Managed Money” reduced their net position another 11,150 contracts to 13.40% of the open interest making the two-week decline 38,080 contracts or -1.76% of the open interest.

In Digest Issue 9 "Rotation Alert [Charts]" we proposed "Managed Money" are trend followers and don’t attempt to pick tops and bottoms, rather they wait to see a trend develop with the “Producer/Merchant/Processor/User,” PMP group and then push the trend until it can go no further. However, based on the last two COT reports this appears not to be the case since the net position of the PMP group increased 58 contracts as of 2-28 and then declined slightly by 2,900 contracts last week. It seems "Managed Money" decided to begin reducing their unusually long net position in late February.

However, if there was one indicator that the crude price was unsustainable it came from weakness in the stock prices of the oil service and exploration & production companies that seemed to reflect diminished expectations for any further advance by crude oil creating a noticeable divergence.

As of 3-7-17, here is the "Managed Money" net position chart shown as percentage of the open interest from the June 10, 2014 high.


Although this is the time of the year when crude prices usually start advancing into the spring buildup, it appers the November OPEC and NOPEC agreement caused prices to rise early in anticipation of production cuts that may now seem as insufficient to bring inventories back to their 5 year average. However, stock prices of E&P along with oil service companies may be in the process of bottoming. They led the decline since December, they may lead the next advance and since sector rotation is an important part of the current equity scene this oversold group is worth watching carefully.

StrategyAlthough current signs of increased hedging activity may be nothing more that another round of "Buy the rumor and sell the news" it may still be prudent to follow the lead of the hedgers using a position with limited and defined risk. There is one hedge idea to consider below.

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SPDR S&P 500 ETF (SPY) 237.69 off .73 points or -.31% for the week after selling off into the nonfarm payroll report before recovering slightly Friday.

The current Historical Volatility is 6.55 and 5.20 using the Parkinson's range method, with an Implied Volatility Index Mean of 9.23 down from 9.26 the week before. The 52-week high was 20.61 on June 24, 2016 while the low was 8.51 on January 27, 2017. The implied volatility/historical volatility ratio using the range method is 1.78 so option prices are somewhat expensive relative to the recent movement of the ETF. While the current implied volatility is near the 52-week low, it will advance back toward the mean around 12.5 should the ETF close below the current upward sloping trendline.

Friday’s option volume was 2,741,392 contracts with a 5-day average of 2,165,090 contracts with narrow bid/ask spreads.

With defined and limited risk, consider this April put spread.


With a slight implied volatility edge the debit would be 1.11 using the ask price for the buy and mid for the sell, about 22% of the distance between the strike prices with 54% of the long call hedged by the short call. Use a close above 240 or a declining VIX after the FOMC announcement Wednesday as the SU (sell/unwind).

The spread suggestion above is based on the ask price for the buy and middle price for the sell presuming some price improvement is possible. Monday’s option prices will be somewhat different due to the time decay over the weekend and any price change.


While the current global economic outlook looks positive, adding a hedge before the FOMC announcement Wednesday will provide some protection against an announcement of more than expected rate hikes this year or unexpected macro or political events.

Twitter Follow us on twitter for more ideas from our scanners and other developments.

Actionable Options™

We now offer daily trading ideas from our RT Options Scanner before the close in the News section of our home page based upon active calls and puts with increasing implied volatility and volume.

"The best volatility charts in the business."

Next week we will be back to the rankers and scanners looking for more trade ideas.

Finding Previous Issues and Our Reader Response Request

PreviousIssuesAll 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. Another source is the Table of Contents link found in the lower right side of the IVolatility Trading Digest section on the home page of our website.

CommentAs 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 at Support@IVolatility.com or use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com website. To receive the Digest by e-mail let us know at Support@IVolatility.com




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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".