« May 2018 »

IVolatility Trading Digest™

Volume 18, issue 19
Correction Update [Charts]

Correction Update [Charts] - IVolatility Trading Digest™

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Review NotesLast week market conditions improved enough to cautiously declare the S&P 500 Index correction ended. The market review below has the details along with a WTI crude oil summary from the Commitment of Traders perspective showing an unusual development followed by a trade idea to consider for SPDR S&P Oil & Gas Exploration & Production ETF (XOP).

Review NotesS&P 500 Index (SPX) 2727.72 advanced 64.30 points or +2.41% last week extending the rebound off the 200-day Moving Average that began on Friday May 4 set off by news that Berkshire Hathaway increased its stake in Apple Inc. The advance met all three objectives mentioned last week, first closing above the 50-day Moving Average, then the April 18, high at 2717.49 and finally above the downward sloping trendline, DSTL.


While the probability of setting off Head & Shoulders Tops in PowerShares QQQ (QQQ) and The Technology Select Sector SPDR Fund (XLK) lessened, the next challenge could be double tops around the March 13 highs and a Head & Shoulders Top could still be possible for The VanEck Vectors Semiconductor ETF (SMH). In the meanwhile, The Energy Select Sector SPDR Fund (XLE) and SPDR S&P Oil & Gas Exploration & Production ETF (XOP) quickly caught up to advancing crude oil and the United States Oil Fund, LP (USO).

VIXCBOE Volatility Index® (VIX) 12.65 dropped 2.12 points or -14.35% last week. Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, declined 2.25 points or -18.64% to 9.82 and the bottom of recent range.


VIX Futures Premium

The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second month futures contracts. With just 2 more trading days until May expiration, the day-weighted premium between May and June allocated 10% to May and 90% to June for 15.65% premium back into the bullish green zone supporting the view that the correction ended.


The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration. At the extremes, declines below 10 and advances above 30 are both unstable.

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Unusual Crude Oil Development

Crude OilWTI Crude Oil (CL) 70.70 basis June futures advanced .98 points or +1.41% last week. Backwardation for WTI, June 18 to June 19, was 5.23 or 7.40% while Brent, July 18 to July 19, was 5.24 or 6.79%, both continuing to suggest tight cash market conditions.

From the Disaggregated Commitments of Traders - Options and Futures Combined - Options and Futures Combined report as of May 8, "Managed Money,” the group that had best correlated with crude oil price changes slightly reduced their net long position by selling longs not by increased short selling resulting in a gradual reduction in the "Large Speculators" ("Managed Money" and "Others") net position to 19.79% of the open interest from 20.68% for the week ending May1 .

On the other side of the equation, Producer/Merchant/Processor/User, "PMP" defined as an entity predominantly engaged in the production, processing, packing or handling of a physical commodity that uses the futures markets to manage or hedge risks associated with those activities, slightly increased their short position, presumably by producer hedging, while their long interest increased more presumably by processors (refiners).

"PMP" shorts added 13,002 contracts, but longs added 34,358 contracts for a net gain of 21,356 contracts for an unusual net long position of 11,725 contracts.


Previously the "PMP" short position exceeded the longs due to producer hedging. However, since March of last year the net short position has been declining and has now turned positive, a noteworthy change. For comparison when cash crude was 106.85 on June 10,2014, the "PMP" net position was -81,892 contracts and then declined to -15,566 contracts by August 12,2014..

Processors appear more concerned about adequate supplies than "Large Speculators" ("Managed Money" and "Others") are willing to aggressively test rising prices although the "Large Speculators" did reduce their net long position modestly.

In addition to declining crude oil inventory levels, further confirmation of a tight market comes from the futures curve backwardation at 7.40% mentioned above, when front month futures are priced higher than the deferred months.

With evidence of a tight crude oil market and the reluctance of the "Large Speculators" to challenge rising prices along with the equities of the producers moving higher, here is long call spread combination idea to consider adding to the United States Oil Fund, LP (USO) suggestion in Digest Issue 18 "China Trade Negotiations [Charts]" last week.

SPDR S&P Oil & Gas Exploration & Production ETF (XOP) 41.27 up 1.66 points or +4.19% for the week having just broken out to the upside above 40 last Tuesday, then gapping higher Wednesday.

With a current Historical Volatility of 26.50 and 25.77 using the Parkinson's range method, the Implied Volatility Index Mean is 25.70 at .20 of its 52-week range. The implied volatility/historical volatility ratio using the range method is 1.00 so option prices inexpensive relative to the recent movement of the ETF. Friday’s option volume was 174,056 contracts with the 30-day average of 173,390 contracts with favorable bid/ask spreads.


Using the ask price for the buy and mid for the sell the call spread debit would be .75 about 38% of the distance between the strike prices. Adding the short put credit at the bid of .77 produces a net .02 credit. With ample time to expiration, use a close back below 40, where there is support, as the SU (stop/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.


Last week the S&P 500 Index closed back above important resistance levels including the downward sloping trendline from the January 26 high at 2872.87, turning the outlook cautiously bullish, supporting the conclusion that the correction ended thereby reducing the need to hedge long equity risk. As upward momentum returned last week it quickly became apparent that the "Just in Case" EEM hedge idea in Digest Issue 18 "China Trade Negotiations [Charts]" was unnecessary. However, until the S&P 500 Index closes above 2802 it continues trading below the medium term operative upward sloping trendline that will be reviewed next week.


The S&P 500 Index correction ended, bonds were up, the yield on the 10-Year Treasury Note remained under 3% and stocks were supported by a slightly lower US Dollar Index. With fewer earnings reports this week more attention will be given to trade and tariff negotiations with China and renewed sanctions on Iran, one factor that's likely supporting crude oil prices.

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Next week will include an update of the medium term trendline along with a market review and more trading ideas to consider.

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 always, 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




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".