« February 2010 »

IVolatility Trading Digest™

Volume 10, Issue 7
Making a Right Shoulder

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Making a Right Shoulder

Of course, our right shoulder is not as in right shoulder arms, but the right shoulder of a technical analysis pattern previously outlined. In this Digest, we update the Right Shoulder progress of the developing potential Head & Shoulders pattern in S&P 500 Index and offer some strategy comments. We begin with our Market Review.

Market Review

S&P 500 Index (SPX) 1109.17. Last week SPX continued working its way higher and without an unforeseen event, it appears likely to continue up into the 1120 area and begin forming the Right Shoulder of a Head & Shoulder Top we suggested Digest issue 5. Since the Left Shoulder could actually be a series of four tops that took a month to develop it is likely SPX will trade in the 1090 -1120 range for a while before completing the right shoulder or breaking out to test the old high at 1150.45 it made on January 19, 2010.

E-mini S&P 500 Future (ESHO) 1106.25. After the March E-mini futures contract made the reversal on February 5, 2010 it continued higher on high volume until last week when the volume and open interest declined modestly on what could have been delayed short covering. We have been waiting to see a decline in open interest to confirm short covering since what we have seen so far is not yet convincing.

S&P 500 Index Implied Volatility (IVXM). Since our last Market Review, the Implied Volatility Index Mean has declined substantially from 23.06 to 17.27. The comparable declined for the VIX was from 26.11 to 20.02 and after making a double peak confirms the minor SPX uptrend that is now underway.

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

A premium over cash is a sell signal, but this week at 7.82% is less than 9.25% for the week of February 12, 2010, but up from the discount of .61% on February 5, 2010. For comparison, the premium was 21.7% on January 8, 2010 just before the last major top. Based upon this, the SPX can continue rising into the 1120 area.

With a current Historical Volatility of 114.85, the next table shows the adjusted Implied Volatility (IV) of the at-the-money (20) VIX calls and puts based upon the Friday closing mid prices for the options and the respective month’s futures prices.


US Dollar Index (DX) 80.64. The dollar index has risen from 77.50 on January 19, 2010 when the SPX peaked at 1150.45. The real dollar driver has been the declining Euro. While there continues to be Sovereign default risk concerns, we also note the Euro usually has a seasonal low in late February, so we can expect to see the Euro turn higher, which will drive the dollar index lower, providing support for equities.

iShares Barclays 20+ Year Treasury Bond (TLT) 89.45. Now at the lower end of the recent range it could be making a double bottom but since risk concerns begin to fade it could continue lower as US interest rates rise.

NYSE McClellan Summation Index 345.61. Our favored early warning indicator improved by 46.16 points during the past two weeks moving higher with the NYSE Composite Index. The trend has turned positive once again and the shorter-term oscillator is well above zero once again.

Baltic Capesize Index (BCI) 3517. During the past two weeks, our preferred Baltic dry-bulk shipping rate index for the larger ships improved by 43 points. On February 18, 2010 Javier Blas wrote a very informative article in the Financial Times saying the scheduled supply of new capsize vessels will increase threefold this year to 335 from 112 vessels last year. He concludes the capsize index will lose its significance as a useful economic forecasting tool and is likely to remain depressed despite good cargo volumes moving to China.

The Capital Link Tanker Index improved 163.97 points or 7.7%. We note one VLCC route, 270’ MEG-Korea is now at $34,284 and has declined from $47,200 in our last report, but is down from $85,107 on January 29, 2010. Weakness here is reason to continue flying the caution flag. caution flag


While the Right Shoulder of the Head & Shoulders Top pattern continues developing as it rises toward the 1120 area it could take some time for it to be completed as we noted above. Since the potential Left Shoulder took a month to develop before the SPX broke out and moved higher to form the potential Head and since there are many good examples of symmetrical patterns in technical analysis there is a good change it will attempt to form some symmetry and trade in the 1090 -1120 range for some time. This will provide an opportunity to make portfolio adjustments and prepare a hedging strategy in the event the next move is to the downside.

If the SPX continues higher on expected dollar weakness resulting from the expected seasonal euro strength then the next hurdle will be a potential double top at 1150.45. If it breakouts out above the old high at 1150.45 then we will return once again to a new upward sloping trendline like the one last described in Digest issue 1 dated January 11, 2010. Until it breaks out caution with new longs is the best strategy.

Seasonal Update

While considering the potential Head & Shoulders Top pattern in the S&P 500 Index here are some ideas for sectors that usually get some seasonal help about this time of the year.

Crude Oil
Natural Gas

In addition, the annual Iron Ore price negations will begin soon and the miners are expected to be asking for prices that are more closely aligned to the spot price at almost double the $60 per ton level that were set for last year.

In Friday’s trading, we noted unusual call options volume and high call put ratios in these stocks.

Cliffs Natural Resources Inc. (CLF) 53.60. US Iron ore producer with a forward p/e of 9.

United States Steel Corp. (X) 53.40. In addition to steel products, it also produces iron ore pellets and coke. The forward p/e is 10.

Arcelor Mittal (MT) 39.44. Luxembourg based, this steel producer is selling at a forward p/e of 8.49.

Here is one more to consider,

Vale S.A. (VALE) 28.82. With a forward p/e of 11.35 Vale has iron ore, coal, nickel and fertilizer.

Upcoming Quarterly Reports

Here are three interesting companies reporting this week to consider.


Mercadolibre, Inc. (MELI) 42.15. With a forward p/e MELI is a growth momentum stock currently following the market higher. With a Historical Volatility of 55.95 and an Implied Volatility of 55.64, both measures are above their current downtrends and appear to be going lower. It could be a short put candidate.


Transocean Ltd. (RIG) 85.12. Rig is now trading at the lower end of its recent trading range with a forward p/e 8.2. The current Historical Volatility is 31.47 and the Implied Volatility is 32.88 and now declining. A long strategy for the sector seasonal tendency is one alternative to consider.


Fluor Corporation (FLR) 45.94. With a forward p/e of 13 this company should give us a reading on the status of global economic recovery. The stock price is currently following the market higher. The Historical Volatility is 35.44 and the Implied Volatility is 36.67 and declining with the rising stock price.

Takeover File

The Wall Street Journal reported Friday Schlumberger Limited (SLB) 63.90 is in “advanced discussions” to acquire Smith International Inc. (SII) 37.70.

There were suggestions that a deal could be announced over the weekend and while the stock gapped up to close 4.35 higher on Friday, we do not yet see the unusual type of high options volume or increasing options implied volatility normally seen when deals are close to agreement.

Both currently have the seasonal advantage and we will add SII to our Takeover File and continue to watch it, if the deal is not announced over the weekend.


The potential developing S&P 500 Index Head & Shoulders Top remains the focus again this week. The strategy is to adjust positions and watch it develop while considering some new selected seasonal longs.

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In next week’s issue, we will update the progress of the potential Head & Shoulder Top and offer specific option suggestions.

Previous Issues and Reader Response Request

Finding Previous Issues and Our Reader Response Reques

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