« October 2010 »

IVolatility Trading Digest™

Volume 10, Issue 40
Oktoberfest 2010

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Oktoberfest 2010

This year, once again, there is a good reason to place emphasis on fest in Oktoberfest as equities are again trending higher just as they were this time last year. For example, last year at this time the S&P 500 Volatility Index (VIX) was 21.43 and now at 19.03, both times at levels suggesting equities are likely to be trending higher. In this Digest, we offer three suggestions for the trend continuation right after our market review.


Market Review

S&P 500 Index (SPX) 1176.19. In the past two weeks, with the help of the Federal Reserve’s talk of more QE, the equity outlook has dramatically changed since our last market review. After clearing the 1150-resistance level and with no further significant technical resistance the S&P 500 Index is trending higher and looks like it will soon challenge the previous April 26 high at 1219.80, the next resistance area.

E-mini S&P 500 Futures (ESZ0) 1175.00. Based upon the preliminary CME report open interest has increased by 256,587 contracts since the September contract expired as the price has risen. When open interest increases along with price, the longs are adding to their profitable positions and/or new longs may be joining in. The additional short sellers may be existing shorts adding their positions and/or new short sellers entering the market. When open interest is increasing it is a sign of a healthy trend underway.

S&P 500 Index Implied Volatility (IVXM). Since our last review two weeks ago, the Implied Volatility Index Mean declined from 19.70 to 17.50, while the VIX declined from 22.50 to 19.03.  

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.


S&P 500 Index Implied Volatility (IVXM)


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 19.02%, compared to 17.16% in our market review two weeks ago. Currently in the mid twenties, this indicator has been rising for 5 weeks suggesting increased hedging of long positions as equities trend higher.

VIX Options

With a current Historical Volatility of 73.85, 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) 14.42, is an exchange traded note based on VIX Short-Term Futures Index offering exposure to a daily rolling long position in the first and second month of the VIX futures contracts and reflects the implied volatility of the S&P 500 Index one month later. The index futures roll continuously from the first month of the VIX futures contract into the second month of the contract.  

The current 20-day Historical Volatility is 44.37 up from 40.89 in our last review, while the 30-day Historical Volatility is 41.88 down from 44.27 in the last review two weeks ago. The IV/HV ratio is 1.85 for a positive volatility spread. 


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


The Implied Volatility Index Mean is 77.54 with the calls at 78.84 and the puts at 76.26 skewed to the calls. The put-call ratio is a very bullish at .40 as call volume increased suggesting options traders are buying November calls and selling October calls perhaps as a hedge. 

US Dollar Index (DX) 77.04. The DX continues to be in the spotlight as the Feds talk of quantative easing puts downward pressure on the dollar and has been the driver for higher equity and commodity prices for the last two weeks. There is good technical support at 76 from last November and December that may slow the downward momentum.

CurrencyShares Euro Trust (FXE) 139.25. As could be expected, US Dollar Index weakness is reflected in euro strength. The euro met some resistance at 140, but it looks as if it can easily continue to 145 before running into stiffer resistance.

iShares Barclays 20+ Year Treasury Bond (TLT) 100.27. Long bonds are now declining having moved lower by 4.34 points in the past two weeks. With the Federal Reserve talking about setting an inflation target of about 2% long bonds are beginning to respond and long interest rates have risen slightly, but quantative easing means supporting long prices so further interest rate increases could be limited as the Fed attempts to flatten the yield curve.

NYSE McClellan Summation Index 952.79. Since our last review, the NYSE Composite Index breadth indicator increased another 131.08 points and is now trending with the market. Interestingly the NYSE Composite Index at 7520.60 led the S&P 500 Index above the last resistance level reflecting the large 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) 84.67. IYT is now approaching the April high at 86.79, while still below, it is tracking the upward sloping trendline from the March '09 low. It will take a breakout above the April high to confirm a resumption of the long- term uptrend. Dow theorist will be watching to see if the transports will confirm other major indices as they approach their April highs.



Trend continuation strategies especially for the big cap technology companies, precious metals and commodity related stocks and ETFs along with the emerging markets equities appear to be the best place to be until the S&P 500 Index approaches its April high at 1219.80. As it does watch for divergences in the advance-decline line or relative strength index for selling clues that could create conditions for a technical correction. For now, more longs are in order and here are three ideas to consider.



Trend Continuation

PowerShares QQQ (QQQQ) 51.49. This ETF is a unit investment trust designed to correspond to the performance, before fees and expenses, of the Nasdaq-100 index. The fund holds all the stocks in the Nasdaq-100 index, which consists of the largest non-financial securities listed on the Nasdaq Stock Market.

Now rising relatively faster that the S&P 500 Index, consider this call ratio backspread. The Historical Volatility is 14.40 and the Implied Volatility Index Mean is 19.22 for an IV/HV ratio of 1.34.


PowerShares QQQ (QQQQ)


The purchase of two Dec 54 calls totals a debit of 1.26 producing a .19 credit for the position. Use a close back down below the support level at 50 as the SU (stop/unwind).


iShares Russell 2000 Index (IWM) 70.29.

The Historical Volatility is 20.31 with an Implied Volatility Index Mean at 27.62 for an IV/HV ratio of 1.33.

Take a look at this put sale as a trend continuation trade

iShares Russell 2000 Index (IWM)


With good volatility edge use a close back below 68 as the SU (stop/unwind).


iShares Silver Trust (SLV) 23.75.


iShares Silver Trust (SLV)


Adding to the bull call spread from last week's Digest Issue 39 consider this precious metals continuation idea. The current Historical Volatility is 22.27 up from 20.74 last week, and an Implied Volatility Index Mean of 34.75, down slightly from 34.95 last week. The IV/HV ratio is 1.56 and the put-call ratio is still bullish at .50.


iShares Silver Trust (SLV)


Use a close back below the gap at 21.64 as the SU (stop/unwind). A close below this level would also be a close below the current upward sloping trendline from the August 24 low of 17.48.

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.



Equities appear to be trending higher and will most likely soon retest their April highs. Stocks and ETFs in the precious metals and commodity sectors along with big cap technology and emerging markets are also reflecting dollar weakness as they move higher.



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In next week's issue, we will again use our ranker and scanners to find more trading suggestions.


Oktoberfest 2010


Finding Previous Issues and Our Reader Response Request

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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".