« March 2010 »

IVolatility Trading Digest™

Volume 10, Issue 11
Greek Tragedy

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Greek Tragedy

Theater at Epidaurus

Officially endorsed as state events in 534 BC Athens, Greek tragedies were literary events, performed in late March/early April at annual state religious festivals honoring Dionysus depicting the downfall of a hero through some combination of hubris, fate, and the will of the gods. Although many tragedies end in misery for the characters, there were also tragedies in which satisfactory solutions were achieved.

Now near the end of March 2010, with the help of modern day media, we are watching a modern day version of a Greek tragedy being played out as protests in the streets of Athens. Without the benefit of classic currency devaluation, it is hard to imagine a tranquil conclusion to this tragedy.

We begin with a review of the markets followed by strategy comments and another hedging suggestion.

Market Review

S&P 500 Index (SPX) 1159.90. The SPX has come a long way since our last review; specifically it has broken out above the previous January 19, 2010 high at 1150.45. Now on the retracement this level should act as support. With the new high, we are able to draw a new upward sloping trendline from the March 2009 low thereby renewing our upside measuring objective at 1233.29 described in Digest Issue 1 dated January 11, 2010.

E-mini S&P 500 Future (ESMO) 1156.25. With the expiration of the March E-mini futures contract we shift our focus to the June contact and note support for the pull back, now underway, is 1143.00. Also noteworthy is total open interest peaked at almost 3.7 million contracts compared to the total at the December expiration of 3.5 million and 3.1 million contracts in September as expanding open interest is a necessary requirement for trend continuation.

S&P 500 Index Implied Volatility (IVXM). Since our last Market Review on March 8, 2010, the Implied Volatility Index Mean declined from 15.04 to 14.66. For the VIX the decline was from 17.42 to 16.97, very 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 indicating the degree of professional hedging, and this week at 20.09% is fractionally lower than last week’s premium of 20.25%, but still very near to the premium of 21.7% on January 8, 2010 just before the last major top. The current reading is very consistent with expectations of a pull back after the breakout.

Now with a current Historical Volatility of 48.33, 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 price.

Implied Volatility (IV) of the at-the-money (17) VIX calls and puts

US Dollar Index (DX) 80.72. After dropping below 80 at mid week DX reversed on Thursday to close near the upper end of the 80 - 81 range reflecting the sudden new found weakness in the Euro as Germany suggested Greece should seek help from the International Monetary Fund and not Euro currency partners. The resulting Euro weakness and the corresponding dollar strength pressured crude oil and raw materials lower.

iShares Barclays 20+ Year Treasury Bond (TLT) 91.26. Since the end of December, long bonds as measured by TLT have traded in a range between 89 and 92. Now at the upper end of the range we expect bond prices will decline again as long bond interest rates rise and then fall based upon fundamental news from Europe and the perceived need to increase or decrease risk trades.

NYSE McClellan Summation Index 1264.16. Our market breadth indicator for the NYSE Composite Index improved another 459.35 points after a 459.20-point advance in the previous week. Since 1000 is considered neutral, a reading above that is positive, but with the NYSE Composite at a new high, the McClellan Summation Index is lagging its high at 1500 made in September creating a divergence of some concern.

Baltic Capesize Index (BCI) 3522. The two-week loss in the Baltic dry-bulk shipping rate index for the larger ships was 401 points and now appears to be in a range between 3500 and 4000. The Capital Link Tanker Index improved 48.54 points, now at 2358.91 as VLCC rates increased substantially on selected routes gaining as much as 73%. It is now well known that the shipping industry is facing serious overcapacity issues that will keep freight rates from rising in the near term. Since shipping is an important component of the Greek economy, the inability to raise freight rates above operating costs is not helpful.


Now that the S&P 500 Index has broken out above our self-proclaimed twilight zone described in Digest Issue 9, we will explore some alternatives for what comes next. Since the S&P 500 Index lagged some other major indexes but has now moved higher it confirms the bullish interpretation.

For those advocates of the Dow Theory it is noteworthy the Dow Jones Industrial Average (DJI) 10,741.98 is now above the January 19, 2010 high of 10,729.90 while the Dow Jones Transportation Average (DTX) 4373.73 is substantially higher than its January 11, 2010 high of 4265.61. According to Dow Theory, this is confirmation for the move higher.

On a cautionary note, the iShares FTSE/Xinhua China 25 Index (FXI) 41.08 is still below its previous high on November 16, 2010 at 46.66. In addition, although doing somewhat better, the MSCI Emerging Markets Index (EEM) 41.19 is still below its previous January 11, 2010 high of 43.47.

Next turning to NYMEX Crude Oil (CL), we see cash at 80.68 while the June future (CL10M) is 81.36 or a .68 premium over cash, called contango. Since the start of the year, the contango has been decreasing from 1.63. Interestingly the contango was .80 in the middle of March last year perhaps reflecting seasonal strength. Contango is a way to measure crude oil demand in the near term by comparing the cash price to the deferred months. In the spring as refinery demand increases the contango narrows. Based upon the narrowing contango we suggest long strategies in the oil and gas sector with emphasis on the companies producing more crude oil than natural gas. We have some suggestions below.

If progress is made toward a resolution to the Greek problems, the Euro will most likely turn higher once again. While currently, a low probability consider, what George Soros once said.

“Markets are constantly in a state of uncertainty and flux and money is made by
discounting the obvious and betting on the unexpected.”

Finally, since we are expecting a correction to retest the breakouts above the previous highs we suggest adding a hedging strategy using an ETF with high options volume and open interest. We offer one idea below. 


Oil and Gas Suggestions

Although not for options strategies, since most are thinly traded, here are three royalty trusts with more than 50% crude oil production with good dividend yields.

Oil and Gas Suggestions

 Since the market Historical and Implied Volatility are now at the lower end of their ranges it is now more advantageous to consider long options strategies such as call spreads and call ratio backspreads with long vega.

The table below has some suggestions to consider for long options strategies in this sector. All have good options trading volume and open interest.


HV = Historical Volatility
IVXM = Implied Volatility Index Mean

In addition, consider the sale of the PBR April 42 put at .49 with an implied volatility of 34.16 based upon Friday’s mid prices.

Long Euro

For those expecting the Greek problems to improve soon here is a long call spread euro idea.

CurrencyShares Euro Trust (FXE) 135.06. The Historical Volatility is currently 8.81.


Use a close below 133 as the SU (stop/unwind).

Hedging the Pull Back

There is no certainly as to the extent of a pull back and retest of the breakout so it is advisable to cautiously hedge while remembering it is a counter trend trade to be carefully watched.

Since we have recently suggested hedges using the VIX this call spread is with a high volume index ETF that has good liquidity.

iShares Russell 2000 Index (IWM) 67.41. The current Historical Volatility is 13.41.


Use a close back up above 69 as the SU (stop/unwind).


After an upside breakout a pull back is now expected for the S&P 500 Index while crude oil prices continue showing seasonal strength. In the meanwhile, if progress made toward solving the problems in Greece the euro will most likely rally.

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In next week’s issue, we will once again offer several additional specific options trading ideas.

Previous Issues and Reader Response Request

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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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".