« October 2010 »

IVolatility Trading Digest™

Volume 10, Issue 38
Hedge Trades

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Hedge Trades


Since the S&P 500 Index along with some other important indices made key reversals on Thursday, we suggest hedging longs until the current resistance area is clearly exceeded to the upside. We have two hedge ideas below followed by a trend continuation alternative idea. We begin with our complete market review.


Market Review

S&P 500 Index (SPX) 1146.24. For several weeks, we have been advocating the trading range case, first with an upper boundary of 1125 and now at 1150, we still think this is the most likely near term course for SPX and the other major equity indices. Last Thursday after trading up to 1157.16, it reversed and closed lower at 1141.20 creating a key reversal. Although it did not meet the key reversal objective of a lower low on Friday, we think it still indicates significant resistance above 1150 and therefore we continue to have a downside near term bias although the upper end of the range is now estimated to be 1150.  

E-mini S&P 500 Futures (ESZ0) 1142.25. Turning to the e-mini, it too formed a key reversal Thursday and made an inside range day on Friday. With the key reversal, open interest declined 45,046 contracts suggesting long liquidation, and then, based upon the preliminary CME report, increased 22,318 again on Friday, as the longs likely bought in again.  

S&P 500 Index Implied Volatility (IVXM). Since our last review two weeks ago, the Implied Volatility Index Mean has moved up slightly from 18.79 to 19.70. The increase for the VIX was smaller going from 22.01 to 22.50.  

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.


VIX Cash


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 15.89%, compared to 14.88% in our market review two weeks ago. Currently in the mid teens, this indicator is still somewhat neutral, but rising.

VIX Options

With a current Historical Volatility of 85.97, 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


VXX Options

iPath S&P 500 VIX Short-Term Futures ETN (VXX) 17.04, is based on the actual VIX not the futures. The current 20-day Historical Volatility is 40.89 down from 44.17 in our last review, while the 30-day Historical Volatility is 44.27 down from 49.02 in the last review two weeks ago. The IV/HV ratio is 1.49 for a positive volatility spread. 


VXX Options


The Implied Volatility Index Mean is 65.85 with the calls at 65.66 and the puts at 66.06 for a skew to the puts. The put-call ratio is a bearish 1.50 as put volume increased suggesting options traders are not expecting further a decline and are selling puts. We offer such a suggestion below as a hedge.

US Dollar Index (DX) 78.09. As the star of last week’s show, DX made an unusual downside move right past the previous support in the 80 range with only a slight there day pause on the prospect of more quantative easing by the US Federal Reserve. The weakness provided some support for equities but was most noticeable in commodities and the precious metals sector. Since there is good support in the 78 area from last December, the rate of decline could now moderate or even attempt to rally.

CurrencyShares Euro Trust (FXE) 137.25. With the dollar weakness and Japan’s intervention to sell yen the currency adjustment shifted to the euro as it blew though what appeared to be the upper end of its trading range at 132.50 and previous resistance at 137.50 from last January. Now it looks as if the next stop will be near the 145 area.    

iShares Barclays 20+ Year Treasury Bond (TLT) 104.61. Long bonds quickly reversed the downtrend above support at 100 sooner than expected. With the US Federal Reserve talking about measures to increase inflation, long bonds are not yet reflecting inflationary concerns. A break below the support at the 100 level, or 4.25% yield, could be the first indication. On yield basis, long bonds are now 3.72% up from the low of 3.46% on August 25.

NYSE McClellan Summation Index 821.71. Since our last review, the NYSE Composite Index breadth indicator increased another 125.95 points taking it above the last pivot around 750. The bulls will be interested to note the NYSE Composite Index at 7335.91 in comfortably above resistance at 7200 with the breadth indicator following higher. One explanation could be the larger number of ADRs and ETFs of non-US companies trading on the New York Stock Exchange that are helped by the declining US dollar and currency translation.  

iShares Dow Jones Transportation Average Index (IYT) 81.46. IYT traded along the 80-resistance level for a week and then worked its way higher last week. In order to reestablish its upward trend from the March ’09 low it would need to be about 10 points higher and this is one reason we continue to favor the range interpretation for the S&P 500 Index. Now looking overbought, it too appears poised for a decline.



As described in the Strategy section of last week’s Digest Issue 37 S&P 500 Index often exceeds technical analysis boundaries and then reverses. This seems to be the case as it now has trouble closing above 1150 as Thursday’s key reversal demonstrated. Accordingly, we continue suggesting caution and note that on any decline the current support is now the August 9 high at 1129.24.



Hedging Longs

Here is a hedging idea with a volatility angle.

iPath S&P 500 VIX Short-Term Futures ETN (VXX) 17.04.

With a current Historical Volatility of 44.27 and an Implied Volatility Index Mean of 65.85 for an IV/HV ratio of 1.49 and a put-call ratio of 1.50 consider these two ideas as hedge candidates.

Short Put


iPath S&P 500 VIX Short-Term Futures ETN (VXX)


Synthetic Long


iPath S&P 500 VIX Short-Term Futures ETN (VXX)


Take a look the volatility chart below showing the current positive volatility spread of 1.49, the Implied Volatility higher than the Historical Volatility. The second chart shows the actual price of VXX and the low made on April 21 at 17.84, which was made when the S&P 500 Index was very near to its April 26 high of 1219.80.


Consumer Discretionary Select Sector SPDR


If the S&P 500 Index continues higher then VXX could continue to drift lower. If there is a correction, however, then VXX could be expected to turn higher. In that case a short put would work. Since timing is always an issue, an alternative to the October short put with only 11 days to expiration would be a November with 46 days to expiration. When we extend the trade out to November, increasing the time to expiration beyond the October options expiration, we have a hedge trade for all of October, perhaps a good idea.

Set the SU (stop/unwind) based upon a close of the S&P 500 Index back up above the top of Thursday’s key reversal of 1157.16.


Trend Continuation

Next, in the event the S&P 500 Index does continue higher and closes above the high of the Thursday's key reversal and the dollar index continues lower as well chances are crude oil will continue increasing. Direct from the "Options Data Analysis" and the "Rankers & Scanners" sections of our home page we offer this "Stock Trend Analysis" suggestion as a regular feature for your consideration. The selection criterion includes an Exponential Moving Average, Relative Strength Index and the Chaikin Money Flow indictor and more. For more details click here.

Chevron Corp. (CVX) 81.95 is a major worldwide-integrated oil and gas company.

Up from a low an August 25 low of 72.57 in a well defined uptrend, but approaching the May 31 high of 83.41, which may create resistance CVX has a bullish rank of 66.67% and could continue higher supported by a declining dollar.

With a current Historical Volatility of 19.03 and an Implied Volatility Index Mean of 21.25 for an IV/HV ratio of 1.12 and a somewhat bearish put-call ratio of .7 consider this synthetic long continuation idea.


Chevron Corp. (CVX)


Use a close back below the August 10 pivot high of 79.48 as the SU (stop/unwind). With a high delta, also consider closing if there are indications that the S&P 500 Index is turning lower.

All of the suggestions above are 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.



Our expectations for an S&P 500 Index decline from the top of its trading range received support from last Thursday’s key reversal. We continue to have a downside near term bias with the upper end of the range estimated to be 1150.



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In next week's issue, we will return to our ranker and scanner tools to find more option trading ideas.


Hedge Trades

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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".