« March 2010 »

IVolatility Trading Digest™

Volume 10, Issue 9
The Twilight Zone

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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The Twilight Zone

Until last Friday the S&P 500 Index was in the process of making an anticipated right shoulder of a Head & Shoulder Top, but with Friday’s breakout to the upside it entered into that zone between 1120 and 1150 called “The Twilight Zone,” that area of uncertainty between a potential new double top, or an eventual breakout to the upside, or the alternative original anticipated Head & Shoulders Top, which is still alive, until SPX breaks out to close at a new high.

In this week’s Digest, we offer observations and a hedging suggestion about traveling in the twilight zone, but first our market review.

Market Review

S&P 500 Index (SPX) 1138.70. Although currently well-extended and likely to pull back somewhat, it now appears SPX will continue up to test the high at 1150.45 made on January 19, 2010. In the likely event it pulls back before reaching the high, there is support at the 1112.42 high of made on February 19, 2010.

E-mini S&P 500 Future (ESHO) 1136.55. The March E-mini futures contract volume last week was on the light side and not very encouraging, however preliminary Friday numbers show better volume at 1.9 million contracts and open interest expanded by 56,370 contracts while ESH0 closed 14.25 higher. Expanding open interest on a large price up day is encouraging for the bulls as is total open interest increasing 64,203 contracts for the week.

S&P 500 Index Implied Volatility (IVXM). Since our last Market Review on February 19, 2010, the Implied Volatility Index Mean declined from 17.27 to 15.04. For the VIX the decline was from 20.02 to 17.42, near the 52-week low of 16.86 made on January 11, 2010.

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

When there is a premium over cash, it is a sell signal, and this week at 17.87% is higher than last week’s premium of 10.18%. For a comparison, the premium was 21.7% on January 8, 2010 just before the last major top. The expanding premium most likely means more hedging activity as SPX approaches the prior January 19, 2010 high at 1150.45.

With a current Historical Volatility of 103.44, the next table shows the adjusted Implied Volatility (IV) of the at-the-money (17) VIX calls and puts based upon Friday’s closing mid prices for the options along with the respective month’s futures prices.


US Dollar Index (DX) 80.43. The dollar index is now trading in a range between 80 and 81 an area where it spent considerable time last May through July. Attention remains forced on the Euro as hedge funds have greatly expanding their Euro short sales according to Chicago Mercantile Exchange data. Presuming the Greek drama improves, watch for selling pressure to diminish giving the Euro a chance to turn higher. Attention is now shifting to the Yen – US dollar interest rate differential and the carry trade.

iShares Barclays 20+ Year Treasury Bond (TLT) 90.27. By the end of the week, the risk trade was back on again reflecting rising interest rates with the declining long bond price. If equities continue higher in anticipation of a better US economy long rates could rise in step.

NYSE McClellan Summation Index 804.81. Our favored NYSE Composite Index indicator improved 459.20 points during the past two weeks, moving higher with the Index, reducing our divergence concerns.

Baltic Capesize Index (BCI) 3923. The two week gain in the Baltic dry-bulk shipping rate index for the larger ships improved by 406 points. In the meanwhile, the Capital Link Tanker Index improved only 14.23 points, as there appears to be little improvement in the tanker sector. AP Moller-Maersk, the world’s largest container line, said they expect reasonable demand for container ships in 2010 with a 3-5 percent increase in demand, but capacity is expected in increase 7-10 percent creating an overcapacity problem shared throughout the shipping industry.


As the S&P 500 Index moved into “The Twilight Zone” on Friday, we review some additional indicators looking for clues as to the probability of the most likely alternative from those mentioned in the in the opening paragraph above.

Above Previous Highs

In support of the continuing higher alternative, here are some ETF’s and indexes that are now trading above their recent prior highs.

iShares Russell 2000 Index (IWM) 66.62. This important ETF appears to be comfortably above the previous high made on January 11, 2010 at 64.88.

NASDAQ Composite (Comp) 2.326.35. Since the previous high was 2326.28 on January 11, 2010 the current close is just .07 higher, but higher.

Apple Inc. (AAPL) 218.95. Called the bell weather for big cap tech, Apple has broken out above the January 5, 2010 high at 215.89 by gapping up on Friday.

Consumer Discretionary Select Sector SPDR (XLY) 31.79. With a gap open Friday XLY is a good distance above the previous high of 30.54 made on January 11, 2010.

Consumer Staples Select Sector SPDR (XLP) 27.59. Following the Consumer Discretionary SPDR, the Consumer Staples is also above its precious high of 29.29 made on December 4, 2009.

iShares Nasdaq Biotechnology (IBB) 89.12. The prior recent high was made on January 20, 2010 at 86.35 so the current close is a good bit higher.

Not Yet Arrived

Now continuing with our unscientific survey here are some other important ones to consider that have not yet made new highs for the current move. The concern here is they could encounter stiff resistance at the precious high creating a double top and then turn lower.

Dow Jones Industrial Average (DJI) 10,566.20. Not yet at a new high, the most recent previous high was on January 19, 2010 at 10,729.90.

Dow Jones Transportation Average (DTX) 4,195.84. For the proponents of the Dow Theory here is another one that has yet to make a high after the recent correction. The previous high was on January 11, 2010 the same day the IWM and others made their previous highs.

PowerShares QQQ Nasdaq 100 (QQQQ) 46.44. With a breakout out to the upside on Friday, it is very near the previous January 11, 2010 high at 46.64.

Energy Select Sector SPDR (XLE) 58.15. The previous high for Energy Select was also made on Janaury 11, 2010 closing at 60.87.

Financial Select Sector SPDR (XLF) 15.22. With another breakout on Friday, the financials are still below the previous high made on October 14, 2009 at 15.76.

Goldman Sachs Group Inc. (GS) 167.18. Although still a good way below the previous high at 193.60 also made on made on October 14, 2009, GS broke out to the upside on Friday, but the volume was not convincing.

NYSE Composite Index (NYA) 7,291.31. The composite index is 180 points away from the previous high made on January 11, 2010 at 7471.31.

FTSE 100 5,599.76. Often used as a leading indicator for the US markets the London FTSE is very near its previous high of 5600.58 made on January 11, 2010.

iShares FTSE/Xinhua China 25 Index (FXI) 41.18. Although the trend is now upward, the previous high was on November 16, 2010 at 46.66, still a good distance away.


Reviewing these sectors and other markets leads to the conclusion: depending upon the fundamental news, equities are now in “The Twilight Zone” and could go in either direction.



Until the direction of the equity markets becomes clear and we see them continuing higher, hedging is still the order of the day. Here is another hedge idea with good edge.

CBOE Volatility Index (VIX) 17.42.

With a current Historical Volatility of 103.44 and with the average between the call and put adjusted at-the-money (17) April implied volatility of 52.10, here is another long call spread suggestion to consider as a hedging strategy.


Comparing the Historical Volatility of 103.44 to the Implied Volatility of the long call of 62.50 and then the short call of 77.50 this hedge has a good edge. In addition, since the VIX is now near the recent lows the downside is limited and is not likely to go much lower.


For now, the S&P 500 Index is in “The Twilight Zone” and unless the energy and financial sectors join the effort by adding momentum, there is insufficient evidence to declare it will continue higher in the near term. One likely scenario is a pull back to test support at 1112.42 before making another run at the previous high. In that event, the VIX hedge suggested above should do well.

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In next week’s issue
, we will offer additional specific option trading suggestions.

Previous Issues and Reader Response Request

Finding Previous Issues and Our Reader Response Reques

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.


About using VIX futures price premiums as an indicator of possible stock market direction, please let me know which of Larry McMillan's publications discussed "When there is a premium over cash, it is a sell signal". Thanks.

Posted by Wimal Samarasinghe on March 08, 2010 at 08:12 PM EST

I am Canadian. Can you handle registered Canadian accounts? (RRSP & TSFA) Thank you. Dorian Shortt

Posted by Dorian Shortt on March 09, 2010 at 02:32 PM EST

Wimal, Thanks for the question about Larry McMillan’s VIX futures premium over cash analysis work. If you are one of his subscribers, you will find several references to this analysis in his newsletters. To get the specific newsletters we suggest you visit his web site or send him an e-mail. Jack

Posted by Jacktrader ( on March 09, 2010 at 06:36 PM EST

Dorian, Thanks for the question. I am not familiar with RRSP and TSFA. Are they types of accounts? Since we are not brokers, we do not have account or brokerage services. Our business is providing options data and analysis services on a subscription basis. For example, we offer the best volatility charts in the business. As for the Digest, we use it as a way to introduce our extensive options data and analysis network. Jack

Posted by Jacktrader ( on March 09, 2010 at 06:48 PM EST

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