« December 2010 »

IVolatility Trading Digest™

Volume 10, Issue 48
Predictably Seasonal

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Predictably Seasonal

While the Treasury bond market staggered as long-term interest rates rose, precious metals kicked off a predictable seasonal decline with key reversals in gold and gold mining equities. In the meanwhile, the S&P 500 Index, while somewhat less predictable also drifted higher with declining volatility. In the market review we have more details followed by two gold charts and a trend continuation suggestion.


Market Review

S&P 500 Index (SPX) 1240.40. The last three days of trading were significant for two important reasons. First, the close last Wednesday at 1228.28 was above the November 15 high at 1227.08, which means concern about a new potential Head & Shoulder Top or a double top has been resolved. Further confirmation came with two higher closes on both Thursday and Friday. Friday's close is particularly noteworthy since it is now above the minimum upside measuring objective of 1233.29 from the March 2009 Head & Shoulder Bottom, described in Digest Issue 1. While it took a long time, and was challenged by a Head & Shoulder Top from the April high that ultimately failed, it has now met the minimum upside objective for this pattern.

E-mini S&P 500 Futures (ESZ0) 1241.00. With three closes above the previous November 9 high of 1224.75, a new upward sloping trendline from the August 31 low can now be constructed. While volume last Monday was on the light side, it returned to normal levels on the breakout Wednesday then continued at a moderate pace Thursday and Friday as open interest expanded for the December expiration rollover.

S&P 500 Index Implied Volatility (IVXM). Since our last review two weeks ago, the Implied Volatility Index Mean declined from 19.17 to 14.95, while the VIX declined from 22.22 to 17.61.  

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.


S&P 500 Index Implied Volatility


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 14.73%, compared to just .50% in our market review two weeks ago that correctly anticipated the December 1 reversal and 25.52 point gain in the SPX. Now in the upper end of the normal range it once again indicates an increased level of hedging activity.  

VIX Options

With a current Historical Volatility of 106.85, 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


The low IV/HV ratio of .63 indicates the movement of the underlying VIX is exceeding the implied volatility of the call options while the puts are trading at significant premiums.

VXX Options

iPath S&P 500 VIX Short-Term Futures ETN (VXX) 38.13. VXX is an exchange traded note based on VIX Short-Term Futures Index offering exposure to a daily rolling long position in the first and second month of the VIX futures contracts and reflects the implied volatility of the S&P 500 Index one month later. The index futures roll continuously from the first month of the VIX futures contract into the second month of the contract.  

Since the VIX futures are usually in contango this ETN will have a downward bias as it rolls from the first month to the second.

The current 20-day Historical Volatility is 65.56, up from 59.38 in our last review, while the 30-day Historical Volatility is 59.93 up from 54.09 in the last review two weeks ago. The IV/HV ratio is 1.02 for a slight positive volatility spread.


iPath S&P 500 VIX Short-Term Futures ETN


The Implied Volatility Index Mean is 60.97 with the calls at 59.70 and the puts at 62.25 skewed to the puts. The put-call ratio is 1.80, normally a bearish reading, but in this case, it is bullish for the SPX since put buyers are expecting VXX to decline with a rising SPX. Alternatively, put buyers could be working the contango roll loss from the December futures contract to the January contract.

US Dollar Index (DX) 80.07. After trading as high as 81.44 on November 30 DX declined to as low as 79.06 on December 3 before turning higher once again as long term US Treasury bond yields advanced on expanding interest rate differentials. Now it is very near the 80 support, a level it has favored on numerous occasions this year. Since there is a seasonal tendency for the US dollar to rise in the last part of December it could well continue somewhat higher.

CurrencyShares Euro Trust (FXE) 131.79. Now very near the same level as two weeks ago, FXE dropped as low as 129.23 on November 30 before rebounding back toward resistance at the 132.50 support level. From a high of 142.28 to the low of 129.23, a 9% decline, in less than a month, the euro continues to be buffeted by a nervous and uncertain euro bond market. As the only other major currency, large moves in the euro are automatically transferred into reciprocal US dollar moves.  

iShares Barclays 20+ Year Treasury Bond (TLT) 93.15. The decline in long Treasury bonds experienced this week as TLT broke down below 95, as interest rates rose as high as 4.50% on December 8, before closing the week at 4.42%, appears to be more than more than just another "risk on" - "risk off" rotation. A majority of bond dealers thought the rise in yields reflected fears about the rising US deficit after the announced proposed tax deal. Less than 30% attributed the rise to the prospects for higher US growth. If right, the nod goes to the bond vigilantes.  

Gold futures December (GCZ0) 1384.30. Last Monday Gold attempted to take out the November 9 high at 1424.30 as it traded up to 1428.40 and then closed at 1415.30. It tried again on Tuesday trading up to 1431.10 and then made a key reversal closing at 1408.30, lower by 7 points on the day as seasonal traders jumped on the first sign of weakness. The failure to take out the previous high along with the key reversal means the Head & Shoulders Top described in Digest Issue 46 is still possible along with an alternative double top. However, it remains above the upward sloping trendline from the July 28 low. If Gold is to continue going lower, it must first close below this important trendline.

NYSE McClellan Summation Index 436.84. Since our last review, the NYSE Composite Index breadth indicator declined another 64.87 points, but by end of last week, it had managed to gain 15.54 points. As the NYSE Composite Index and the S&P 500 Index broke out above their April highs, the McClellan Summation Index turned lower creating a noticeable divergence indicating equities were being sold into the breakout or focus had shifted to fewer larger capitalization names with greater liquidity. Now with the NYSE Composite Index back in new high territory this continuing divergence is a real concern for the bulls.

Baltic Capesize Index 2694. Since we last looked at this index in Digest Issue 34 on September 7, the bulk shipping rate index for the larger ships carrying iron ore and coal declined 1243 points most likely due to increasing lift capacity from more ships entering into the trade. It was the substantial number of new ships arriving that caused us to remove this index from our market review, as it was reflecting the supply and demand imbalance in ship capacity and longer reflecting economic activity.

Capital Link Container Index  1980.22. Since Digest Issue 34, the important container sector index declined 103.84 points, after recovering about 130 points from last month on increased holiday traffic. The problem here is also excess shipping capacity from new building arrivals in the container trade.

Capital Link Tanker Index 2336.14. Despite the index improving by 159.72 points since our last review, in Digest Issue 34 the tanker sector continues to operating below breakeven rates in some categories, based upon spot charter rates. Some improvement has recently been seen in the rates for the smaller Aframax size ships, but new scheduled ship deliveries are responsible for the dismal VLCC rates. As we previously wrote, in the very large crude carrier sector 180 new ships, or about one-third the size of the existing fleet, are scheduled for delivery in the next two years.

iShares Dow Jones Transportation Average Index (IYT) 92.29. Up another 3.95 since our last review and more importantly closing well above the previous November 15 high of 89.57, IYT is moving higher with the S&P 500 Index supporting the bull case for the Dow Theory advocates. While ocean shipping suffers from capacity excess, airfreight, rail and trucking are all doing extremely well.

Ben Delivered QE2

While US equities quietly work their way higher, there are still some unresolved technical indicators including the McClellan Summation Index and the 9-week RSI divergence. In addition, there remains some concern from potential Head & Shoulders Tops in the iShares MSCI Emerging Markets Index (EEM) 46.59, and iShares FTSE/Xinhua China 25 Index (FXI) 43.43.  

While there is a chance the current uptrend in the S&P 500 Index will stumble after the expiration of futures and options on Friday, it now appears the performance-seeking portfolio managers will have the upper hand going into year-end and push US equities higher.

More Gold

Using SPDR Gold Shares (GLD) 135.41, for an added perspective our friends at Options Trading Signals sent these charts over.


SPDR Gold Shares


SPDR Gold Shares



Trend Continuation

iShares Russell 2000 Index (IWM) 77.75.

Since the August low, IWM has handily outperformed the S&P 500 Index, here is a trend continuation idea based upon the assumption it continues higher into year-end.

We suggested a put sale as a long proxy trade in Digest Issue 40 when it was 70.29 and then again as a hedge trade in Digest Issue 42 at 70.30.   

With a current Historical Volatility of 18.10 and an Implied Volatility Index Mean of 20.62 with an IV/HV ratio of 1.14 and a bearish put-call ratio of 2.00 (a hedging favorite) consider this long call spread combination.


iShares Russell 2000 Index


With good volatility edge in the sold put, use a close back down below the last pivot and below the upward sloping trendline from the August low at 72.03 as the SU (stop/unwind).  

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.



Although there are still some unresolved technical divergences, the major US equity indices appear to be headed higher going into year-end. Due to the December seasonal tendency for gold to decline, the outlook remains uncertain.


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Since this is the final issue for 2010, the next will be on January 3, 2011 when we will review the market developments that occurred in the final weeks of the year. Happy holidays from the IVolatility Trading Digest team.


Predictably Seasonal


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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".