« February 2010 »

IVolatility Trading Digest™

Volume 10, Issue 4
January Barometer

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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January Barometer

After a brief review of the January Barometer, we update our Strategy section comments and offer a few more hedging and shorting ideas.

At this time last year, we were busy updating the Takeover File and neglected to report the results of 2008 January Barometer. As a result, we will now update the record for both years.

According to Yale Hirsch of the Stock Trader’s Almanac January’s close up or down determines the likely direction of the S&P 500 Index for the year. On December 31, 2007, the S&P 500 Index closed at 1468.36 and on January 31, 2008, it closed at 1378.55, a decline of 89.81 points. As of 2007, according to Hirsch, there had been 21 down Januarys since 1953 with 16 closes lower for the year and only 5 higher for a 76% probability of a lower year-end close in the years when January closes lower.

So what was the 2008 result? It opened at 1468.36 and recorded another down January with a close at 1378.55. Accordingly, the SPX then closed lower for the year at 903.25, so the record at year-end 2008 was 22 down closes in January with 17 closes lower for the year; a 77% probability of lower year-end closes.

For 2009, SPX opened at 902.25 and the January close was 825.88, so based upon the above there was a 77% chance the SPX would close lower on the year. Well at year-end, it was higher, not lower closing at 1115.10. Some market pundits say 2009 was an abnormal year as the January Barometer confirms. So now, the updated record is 23 lower January closes since 1953 with 17 lower closes at year-end and with just 6 higher closes, still a 74% probability of a lower close.

For 2010, the opening was 1115.10 and the January close was 1073.83, a 41.27-point decline. Based upon past record, the January Barometer says there is a 74% probability that the SPX will close lower at year-end.


In last week’s Digest issue 3, we reported that the VIX futures were selling a discount, indicating a buy signal. The anticipated turnaround has not materialized and this week the futures are back to a very slight premium of 1.1%. In addition, the four previous spikes in the VIX were quickly followed by a sharp decline, but so far, this VIX retreat is lingering and not giving its usual clear indication all is back to normal.

While SPX closed below 1080 and below our previously defined trading range, we also remember that SPX has a tendency to overshoot objectives, so for now it looks to be going lower, but could still make a stand here and trade back up into the trading range. A look at some of the other indexes suggests this is not a very likely outcome. Technology and Basic Materials, two previous market leaders now appear to be declining faster than the broader indexes. As result, we now suggest more hedging and short biased trading plans.

More Hedging Suggestions

If the SPX continues lower, the next attempt to turn up should be in the 1030-1040 area. When hedging or shorting, especially against the longer-term uptrend we prefer to use ETFs to reduce company specific risk, such as a takeover announcement, a new product announcement, a resource discovery, or other good news that would cause large up moves. Accordingly, here are some ETFs with good liquidity that could be considered for hedges or shorts.

iShares FTSE/Xinhua China 25 Index (FXI) 38.36

Financial Select Sector SPDR (XLF) 14.18

Energy Select Sector SPDR (XLE) 54.50

Materials Select Sector SPDR (XLB) 30.14

Technology Select Sector SPDR (XLK) 20.93

As an example, here is a put -ratio backspread hedge using the iShares Russell 2000 Index (IWM) 60.11.

With a current Historical Volatility of 18.03, it is now turning upward as IWM gains momentum to the downside. The current Implied Volatility Index Mean is 25.11 having turned higher about two weeks ago.

Looking at the chart we see 62 was a previous support area that did not hold, but becomes a good upside target to use as our SU (stop/unwind) in the event we see an upside reversal. Next, we see 56 another area of previous support, as a good downside objective. Using these chosen objectives we want to use a strategy is long Vega or will increase in value as the implied volatility increases, since we know that implied volatility has a tendency to rise as the underlying declines.

Further, we want to use options that have enough time to reach their objective and since we want long Vega, we will have short Theta or time value, so options with more time value have lower negative Theta and higher Vega.

As a result, we select the March 61 put and the March 58 put to construct a put ratio backspread. We will sell 1 March 61 put and buy 2 March 58 puts, in this case for a debit. Here are the legs for this spread.


This suggestion is based upon the Friday mid prices between the bid and ask. The March 58 puts were 1.57 each so for the 2 puts the total is 3.14 as shown above. Similarly the deltas were -.3468 each so the total negative delta would be -.6936, as shown above. The prices on Monday will be slightly different due to time decay and will have to be adjusted for any price change in the underlying.

The implied volatility of the long puts at 28.55 is higher than the short put at 25.68, and can be considered as the cost of insurance to protect other long positions.

Based upon the above and using a SU (stop/unwind) set at 62 we would have a downside risk of $28 and an upside of $105 at our 56 objective. A look at the risk profile (not shown) shows it flat at negative $38 for higher prices representing our debit cost and then steeply rises upward at the lower prices. The maximum risk is the debit or $38, but can be reduced by closing the position in the event IWM turns higher and closes above the SU at 62. The initial margin requirement is $342.

Similar trades can be structured for any of the ETFs listed above by following the same set up for put ratio backspreads.

Another Hedge with an Edge

United States Oil (USO) 35.64.

For another downside trade USO has two real advantages. First, this is the seasonally weak period for crude oil and secondly the crude oil futures are still in contango which means when the next month futures are bought they pay a premium that disappears at expiration when the futures prices equal the cash price. In addition, crude oil futures at 72.89 basis March are at a critical support level that has the potential to set off a double top from the October – January highs implying a downside measuring objective at 60.65. The equivalent objective on the USO chart is down at 32.

Here is a similar put- ratio backspread for the USO using April options.


This suggestion is based upon the Friday mid prices between the bid and ask. The April 34 puts were 1.43 each so for the 2 puts the total is 2.86 as shown above. Similarly the deltas were -.3505 each so the total negative delta would be -.7010 as shown above. The prices on Monday will be slightly different due to time decay and will have to be adjusted for any price change in the underlying.

As for the SU (stop/unwind) we would close or begin to unwind this one if USO closed back above 38.

Long Stock Ideas

For those who may see the current equity market environment as a buying opportunity here are two ideas from our rankers and scanners. While they do not have sufficient options volume or open interest for options strategies, they could both be good stock purchases as they both are showing unusual relative strength in this weak market.

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 details of this analysis tool click here .

Equifax Inc. (EFX) 32.00.

At the current price it is currently selling at a p/e of 17 with a forward p/e of 13 paying a .04 quarterly dividend. So far it has given no indication of a price decline and remains above the upward sloping trendline from the low below 20 last March.

As a regular feature on our home page, we offer the “Best Calendar Spread” suggestion found at the bottom of the “Options Data Analysis” and the “Rankers & Scanners” sections. The scan result is a long call calendar spread based upon the differential between the implied volatility of the near term call compared to the implied volatility of the deferred call. Here is an interesting idea from Friday’s scan.

Ross Stores Inc. (ROST) 45.93.

This off-price retailer is currently selling at a p/e of 14.6 with a forward p/e of 12 paying .11 quarterly dividend. It reported earnings of .84 on November 19th and the next scheduled earnings date is March 18th with the mean analyst estimate at 1.16 per share. The stock is up from 42.30 on January 4, 2010.


The equity markets have been trading lower for two weeks and are near or below important support levels as many recent earnings reports have been followed by selling especially in the momentum stocks. While they are oversold and we are beginning to hear talk of bargain hunting there is no indication they are ready to turn higher so we encourage more hedging and shorting strategies.

Visit us at twitter for more ideas from our scanners and other developments

IVolatility.com Bookstore. In addition to the vast number of articles on our web site, take a browse through our bookstore for more reference information and material.

In next week’s issue, we will have our detailed Market Review and remain focused on the direction of the equity markets..

Previous Issues and Reader Response Request

Finding Previous Issues and Our Reader Response Reques

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.

As usual, 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. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website. If you would like to receive the Digest by e-mail let us know at Support@IVolatility.com.


Is the IVolatility Digest still being published? I always enjoyed reading this but haven't received a copy for the past two weeks.

Posted by Dennis Fullerton on February 24, 2010 at 09:51 PM EST


Thanks for the question about the Digest publication schedule. We confirm that we continue to publish. Usually a draft copy is on our web site Sunday afternoon with the final edited version available on Monday mornings as we send the e-mail edition it to our subscribers. If you are no longer receiving the e-mail edition and would like to receive it again send an e-mail to support-AT-ivolatility-DOT-com and we will get you back on the list.


Posted by Jacktrader ( on March 09, 2010 at 07:04 PM EST

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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".