« October 2015 »

IVolatility Trading Digest™

Volume 15 Issue 43
Retracement Quandary [Chart]

Retracement Quandary [Chart] - IVolatility Trading Digest™

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Is the current retracement a selling opportunity, or a continuation of the previous uptrend? Along with our regular bi-weekly market review and “Foremost Six” update, we look at the S&P 500 Index chart updating the trendline status along with some thoughts as to where it may go followed by a long earnings idea for Starbucks Corp.


Review NotesS&P 500 Index (SPX) 2075.15 closed the week up 42.04 points or +2.07% confirming the double bottom pattern with a 2172 upside measuring objective and solidly above resistance at 2050. The chart below offers some thoughts about the previous uptrend that apparently ended August 20 and considers if the current retracement advance will soon fail.

CBOE Volatility Index® (VIX) 14.46, based on real-time prices of options on the S&P 500® Index, constructed to reflect investors' consensus view of future (30-day) expected stock market volatility, declined .59 last week closing below 15 for the first time since August 18 just before SPX closed below the upward sloping trendline on August 20.

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.




With 17 trading days until November monthly expiration, the day weighting applied 85% to November and 15% to December for a 15.45% premium shown above. Our alternative volume-weighted average between November and December regularly found in the Options Data Analysis section on our homepage was slightly higher at 16.13%.

While day-to-day VIX changes offer little forecasting insight following the VIX futures premium helps since it measures expectations of tactical professional traders and money managers using VIX futures and options for hedging long portfolio risk.

Premiums for normal term structures during uptrends are 10% to 20% while premiums above 20% are unsustainable suggesting a lack of enthusiasm for VIX hedging often occurring around market highs suggesting overbought conditions associated with pullbacks. Alternatively, premiums less than 10% suggest caution and negative premiums indicate oversold conditions. Last week the volume-weighted premium started in the caution zone at 4.72% advancing every day to end at 16.13% well into the green zone.

VIX Options

With a current 30-day Historical Volatility of 111.93 and 116.14 using Parkinson’s range method, the table below shows the Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon Friday’s closing option mid prices along with their respective month’s futures prices, since the options are priced from the tradable futures.




Compared to the current range historical volatility of 116.14 both November and December at-the-money options are inexpensive relative to recent movement of the VIX futures. Friday VIX futures traded 196,296 contracts while options on the futures traded 836,102 contracts.


All of the Implied Volatilities along with the Historical Volatilities and Greeks for the VIX options based upon the futures prices are on our Advanced Options page, found by clicking on the “market close” link shown near the top of the page.


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Foremost Six

In last week’s order of perceived importance once again:

US Dollar Index (DX)
United States Oil (USO)
China A-Shares ETF (ASHR)
Market Breadth
iShares Transportation Average (IYT)
ProShares UltraShort 20+ Year Treasury (TBT)

Expanding on four of the top six:

US Dollar Index (DX) 97.13 up 2.59 or +2.74% most coming Thursday and Friday after announcements from the ECB that further possible easing will be considered along with the interest rate reduction notice from the People's Bank of China (PBOC). The stronger dollar will renew pressure on large cap multinationals and commodities especially crude oil.

United States Oil (USO) 14.27 as a proxy for WTI Crude Oil declined .95 or -6.24% for the week as the December WTI futures declined 3.12 or -6.54% closing at 44.60. While USO remains above support at 14, the futures closed below the 45 support level.

Updating the CFTC Commitment of Traders report for October 20 shows the “Managed Money” group increased their short positions 16,496 contracts reducing their net long position from 184,317 to 168,197 representing 6.99% of the open interest down from 7.37% the prior week while the total open interest declined by 94,965 as the November contracts expired Tuesday.

China A-Shares ETF (ASHR) 36.90 up .71 or +1.96% for the week and this is before the People's Bank of China (PBOC) cut the one-year lending rate Friday by a quarter of a percentage point, to 4.35 percent, effective Saturday. In addition, they cut required reserve ratio for banks another 50 basis points for qualifying institutions.

Market Breadth The McClellan Oscillator Summation Index reported by McClellan Financial Publications, advanced another 589.26 points last week to 2182.48. Relative to the question of selling the retracement, according the Tom McClellan the more important measure is the ratio adjusted Summation Index that advanced from 187.38 the prior week to 373.06 almost doubling. Should the ratio adjusted index turn lower it will confirm the countertrend rally ended while an advance above 500 will confirm a resumption of the long-term uptrend. The ratio adjusted index is available at StockCharts.com symbol $NYSI and the traditional index is $NYSIT.

S&P 500 Index Uptrend

While most of the commentary about selling the retracement from the August 24-25 lows seems biased toward the bears it seems worthwhile to look at the long-term trend perspective before concluding its best to sell the retracement. Although some sectors such as biotech, healthcare and retail are experiencing dramatic declines, it could just be more rotation out of sectors now perceived as overvalued.

The primary uptrend that began October 4, 2011 at the 1074.77 low, ended August 20 as reported in Digest Issue 34 "Over the Cliff." The subsequent swift decline down to the August 25 low at 1867.30 followed by a counter trend rally back up to the Sept 17 reversal high of 2020.86 formed a rising wedge activated on Sept 18 with a measuring objective down at 1812. However, before reaching the objective it reversed on Sept 29 after making a low at 1871.91. Turning up once again it set up a potential double bottom activated Oct 15 and subsequently retested on Oct 21, as it closed back below the key 2020.86 level, finally resolved Thursday on more stimulus news from the ECB and China thus confirming the double bottom now very prominent on long term charts.




Since SPX failed to reach the rising wedge downside measuring objective at 1812 it creates doubt about the start of new downtrend. Stopping short of the rising wedge objective on Sept 29 and forming a double bottom pattern, since activated, suggests the breakdown from August 20 may have been the end of an Elliott 3rd wave from the October 2011 low shown above. If so, the August 24-25 decline defines an Elliott 4th counter trend wave and the current advance could become the final 5th wave extending somewhere above 2200.

However, broken trendlines often become resistance as prices return to test them once again and this where SPX closed Friday, right up against the trendline resistance. If the new 5th wave interpretation is correct then it should continue higher and then go on to close back above the July 20 high of 2132.82 and the May 21 high of 2134.71 before reaching the double bottom upside objective MO at 2172 shown above. However, there are several fundamental problems with this interpretation including valuation, the dollar advancing again, a possible interest hike by the Federal Reserve and continuing cyclical rotation out of higher valued sectors. In addition, another technical concern was Friday’s low SPX put call ratio, a contrarian overbought indicator now at the lowest level since last December right before the pull back that began December 31, 2014 suggesting trouble at the trendline resistance.


strategyWhile evaluating the current market technical condition also consider the deteriorating economic picture.

China reported Q3 GDP of 6.9%. Capital Economics estimates that China’s GDP is actually expanding at just 4.5 percent.

"…Chinese economic data is more artificially processed than an Oreo." – Steve Reitmeister at Zacks

Friday after the markets closed the People's Bank of China (PBOC) cut the one-year lending rate by a quarter of a percentage point, and cut required reserve ratio for banks and another 50 basis points.

In the U.S., the Fed cites the strong dollar as restraining manufacturing activity as well as tourism spending while the appetite for consumption has clearly downshifted in recent months. The Japanese cut production of autos, electronic machinery, and computer memory due largely to concerns about decelerating economic growth in China.

Thursday European Central Bank President Mario Draghi, said that the central bank will "re-examine" its asset purchases at the December meeting, immediately interpreted as more monetary easing on the way, sending the euro lower while European equities and U.S. futures spiked.

By the end of the week, equities were in "risk-on" mode once again.

From the perspective of distorting the saving and investment function while encouraging more companies to borrow at ultra-low interest rates to continue purchasing outstanding shares – additional monetary stimulus seems like lunacy. Here is a quote from last week worth repeating.

"The lunatics are running the asylum." – Michael Lewitt

In the meanwhile, the Elliott wave technical condition confirms equity prices may continue higher although facing three near term areas of resistance detailed above that could change the outlook. Remember, "Technical Analysis is a windsock, not a crystal ball." – Erin Heim

While the momentum is up her is another "don’t fight the tape," idea.

Earnings Momentum

Starbucks Corp. (SBUX) 62.61+1.12. Scheduled to report 4Q earnings Thursday after the close with a consensus estimate of .44 per share, relatively expensive fundamentally, with a 35 price-to-earnings ratio, 33 forward price-to-earnings ratio and a price-to-earnings growth ratio of 2.21. The rationale is momentum into the earnings report.

The current Historical Volatility is 20.44 and 20.94 using the Parkinson's range method, with an Implied Volatility Index Mean of 25.45 down from 26.01 the week before. The 52-week high was 40.38 on August 24, 2015 while the low was 15.50 on December 5, 2014. The implied volatility/historical volatility ratio using the range method is 1.25 so option prices are about right relative to the recent movement of the stock. However, for comparison the at-the-money 63 call implied volatility was 40.80 while the put was 43.03 for the weeklies expiring this Friday. Last Friday’s option volume was 41,624 contracts traded compared to the 5-day average volume of 32,100.

Here is a short-term call spread idea for next week based upon expectation for a continuing price increase before the earnings report.




Using the ask price for the buy and mid for the sell the call spread debit would be .30 about 12% of the distance between the strike prices. With 26 days to expiration and with both options out-of the-money the spread partially hedges time decay and implied volatility. Should it decline back below 60 before the report close it out sooner, also close it sooner if it should spike up before the report, otherwise the plan is to hold on since it previously advanced after reporting.

The above suggestion uses Friday’s 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.


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While much of the bearish market commentary suggests the current upswing is another opportunity to sell the retracement, from a longer term Elliott wave perspective it appears the August decline was a countertrend Elliott 4th wave and the 5th may now be underway. However, there is important upside resistance and any further advance contradicts both valuation and deteriorating global fundamentals.


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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.


For next week’s issue, we will fire up the rankers and scanners looking for new interesting trade ideas.


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. 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.

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Production issues caused a delay in publishing this week’s Digest. Referring to the chart in the Digest SPX closed above the long-term trendline yesterday while the VIX futures premium advanced to close in the green at 13.53%. Expect some resistance at August 18 high of 2103.46. Jack

Posted by Jack on October 29, 2015 at 07:46 PM EDT

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