« September 2019 »

IVolatility Trading Digest™

Volume 19 Issue 39
S&P 500 Index Price-to-Earnings Ratio [Charts]

Crude Oil Rocket [Charts] - IVolatility Trading Digest™

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Before third quarter earnings reporting begins we look at already reported earnings of the S&P 500 Index and the current price-to-earnings ratio. While some analysts claim equities appear expensive others say lower interest rates justify a higher valuation. Our regular Market Review includes two charts to help explain.

Review NotesS&P 500 Index (SPX) 2961.79 declined 30.28 points or -1.01% last week rolling over to test support at the 50-day Moving Average. Although the distance from the upward sloping trendline, USTL widened, support at the 50-day Moving Average may limit any further decline with the help some positive China trade news.


The gap below the 50-day Moving Average and 2940, created when it broke out of the previous trading range, makes a tempting target and an important support zone. With the help of some positive China trade news it could be enough to end the pullback.

S&P 500 Index Earnings

To calculate the price-to-earnings ratio first it's necessary to define earnings from the many available choices. EBITD, or earnings before interest taxes and depreciation also called cash flow or Operating Earnings, excludes items managers claim are beyond their control in the short-term. Then there are many projected forward earnings estimates subject to assumptions about growth rates, sales, future interest rates and numerous other variables. Finally GAAP, or Generally Accepted Accounting Principles earnings are the ones in their Quarterly 10K reports submitted to the Securities and Exchange Commission referred to by Standard & Poor's as Reported Earnings.

Courtesy of our friends at StockCharts.com the S&P 500 Index chart below shows the index for the last year along with GAAP earnings for the preceding 12 months reported each quarter. Here they were as of last Thursday September 26.


Using GAAP earnings of 134.39 as of last Thursday, the price-to-earnings ratio is 22. While some analysts call ratios above 20 overvalued, applying the Rule of 20 guideline that says a fair value ratio is 20 minus the inflation rate, the ratio would be 18.4, based on the FRED data base at the Federal Reserve Bank of St. Louis showing the PCE inflation rate excluding Food and Energy at 1.6%, as of September 26. Considering interest rates are currently lower than they were when the Rule of 20 was popular, 22 times GAAP Reported Earnings seems about right. Not too hot nor too cold.

VIXCBOE Volatility Index® (VIX) 17.22 advanced 1.90 points or +12.40% 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, gained 1.91 points or +14.75% to end at 14.86% vs. 12.95% on September 20, as the chart shows.


As the bulls and bears are aware, implied volatility increases as SPX declines.

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 12 trading days until October expiration, the day-weighted premium between October and November allocated 60% to October and 40% to November for a premium of 6.40%, in the yellow caution zone between 0% -10%, compared to 13.73%, for the week ending September 20.

The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month futures contract converges with the VIX at expiration on October 16.


For daily updates, follow our end-of- day volume weighted premium version located about halfway down the home page in the Options Data Analysis section on our website.

Big Data? In options, we are Big Data!
For a comprehensive review and reminder, check this out
Options: Observations of a Proprietary Trader  

Hedging Strategy

VIXAs the S&P 500 Index rolls over the hedging strategy needs updating. The caution and hedge images began appearing in the Strategy section of Digest Issue 32 "Option Spreads [Charts]"on August 12, 2019 and have remained in this space ever since. Now as SPX approaches support at the 50-day MA it seems prudent to call for an increase of long position hedging to ~50% in the event support fails below the gap around 2940. If so, the next support would be down around the 200-day MA currently at 2833.

If support in the zone between the 50-day Moving Average and the gap around 2940 holds, then new hedges will likely be unnecessary, but since it all depends upon China trade news, maintaining a somewhat lower level of hedging should be sufficient. For example, November 15 out-of-the-money SPDR S&P 500 ETF (SPY) put spreads.


The S&P 500 Index rolled over to test the 50-day Moving Average last week and depending on China trade news could go either way as it tests the support zone between the 50-day Moving Average and 2940. Consider increasing hedges against further downside if it moves into the gap below the 50-day Moving Average. Using GAAP earnings, the price-to-earnings ratio of 22 seems reasonable in the current low interest rate environment. Until the S&P 500 Index closes back above the important upward sloping trendline, continue hedging long positions.

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Actionable Options™

We now offer daily trading ideas from our RT Options Scanner before the close in the IVolatility News section of our home page based upon active calls and puts with increasing implied volatility and volume.

“The best volatility charts in the business.”

Next week more Market Review and indicator updates.

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 our website homepage.

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





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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.

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