« February 2018 »

IVolatility Trading Digest™

Volume 18 Issue 8
Correction Likely Over [Charts]

Correction Likely Over [Charts] - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Until Friday of last week, it seemed the correction would continue for another week or perhaps longer, and then the S&P 500 Index closed above the upper boundary of the consolidation pattern, shown in the updated chart below. Since several other indicators including market breadth now confirm the advance, this issue includes ideas for ProShares Short VIX Short-Term Futures ETF (SVXY) and iShares MSCI Emerging Markets ETF (EEM) to begin testing the long side again.

Review NotesReview NotesS&P 500 Index (SPX) 2747.30 added 15.08 points or +.55% for the week including 43.34 points Friday as it closed above the upper boundary of the potential symmetrical continuation pattern that was intact as of the close Thursday. The chart shows it continued too far into the apex and then broke out, casting serious doubt about the viability of the pattern, while closing above the 50-day moving average at 2730.88, now the first support.


Chart Courtesy of StockCharts.com, IVolatility

VIXCBOE Volatility Index® (VIX) 16.49 declined 2.97 points or -15.26% for the 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 1.80 or -13.09% closing at 11.95.


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 17 trading days until March expiration, the day-weighted premium between March and April allocated 68% March and 32% to April for a 1.95% premium, still below the bottom of the green zone between 10% to 30%, but positive for the first time in three weeks.

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.


As the VIX declined the futures curve returned to its normal contango position so the premium turned positive. In the past, this has been a reliable end of correction signal.

Since VIX options are used for hedging, declining VIX option implied volatility adds confirmation that the correction is in the process of ending.


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Return to the long side

ProShares Short VIX Short-Term Futures ETF (SVXY) 13.18 gained +.49 points or +3.86% for the week. Now that VIX has closed back below the futures it will regain the contango edge and advance as the VIX declines. When the futures trade above the cash VIX (contango), until front month future converges with the VIX at expiration, SVXY advances captures the futures premium loss.

Since the current Historical Volatility is abnormally high at 530.14, use the Parkinson's range method, at 107.66, with an Implied Volatility Index Mean of 75.50 and likely to continue back down toward 59. The implied volatility/historical volatility ratio using the range method is .70 so option prices are inexpensive relative to the recent movement of the ETF. Friday’s option volume was 55,440 contracts with the 5-day average of 37,720 contracts.

Consider one of these out-of-the money long calls with defined and limited risk.


Adding a short put makes it a synthetic long or risk reversal with an attractive implied volatility edge since the implied volatility of the sold put is considerably higher than the long call. However, it greatly increases the risk of loss in the event VIX spikes higher as recent experienced demonstrated, should the market turn lower once again. Keeping the risk in mind, here is a synthetic long carry trade idea.


Should the S&P 500 Index open higher today adjust the strike prices higher as well. Based on Friday's ask price for the buy and bid for the sell the debit would be 1.38. Should the VIX start advancing again, close it out or buy back the short put to limit the risk.

One more walk on the long side

iShares MSCI Emerging Markets ETF (EEM) 49.72 gained .18 points or +.36% for the week. This top ranked ETF has been highly correlated with the S&P 500 Index since the start of the year as shown by the green arrow below. Both benefit as the US Dollar Index (DX) declines so watch the small double bottom that could be underway since any further DX advance would create a headwind.


Chart Courtesy of StockCharts.com

First the option data.

Since the current Historical Volatility is 27.50 and 19.10 using the Parkinson's range method, with an Implied Volatility Index Mean of 19.02 and likely to continue back down toward 16. The implied volatility/historical volatility ratio using the range method is 1.00 so option prices are inexpensive relative to the recent movement of the ETF. Friday’s option volume was 77,256 contracts with the 5-day average of 266,180 contracts with reasonable bid/ask spreads reflecting high options volume making it one of the better ETFs for multiple option strategies.


Using the ask price for the buy and bid for the sell the debt would be1.11. Use a close back below the last pivot at 48.50 as the SU (stop/unwind).

The suggestions above are based on the ask price for the buy and ask price for the sell. Monday's option prices will be somewhat different due to the time decay over the weekend and any price change.


More reliable indicators, especially the negation of the S&P 500 Index symmetrical continuation pattern and the VIX futures premium turning positive last week added to the improvement from the week before, delighting the bulls who may want to start carefully increasing their long positions again.

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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 the plan includes a look at some seasonal trade ideas in the oil and gas sector along with our market review.

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




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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".