IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

After another large decline last Thursday, equities along with other "risk-on" assets appear poised for a relief rally that could comeearly in the week as the markets begin anticipating and debating what Federal Reserve Chairman Ben Bernanke may deliver in his Friday speech. It was in last year's speech from Jackson Hole when the Chairman unveiled QE2 setting the stage for an equity rally that helped to boost the S&P 500 Index by 32% before reaching a top on May 2, 2011. Although the early comments do not reflect high expectations, unless there is news of more negative developments in Europe chances are we can expect some short covering before the speech, after all nobody knows what he may pull out of his hat. We have more details in our market review along with two trade ideas.
Market Review S&P 500 Index (SPX) 1123.53. The minimum downside-measuring objective of 1145 for the Head & Shoulders Top that we detailed in Digest Issue 28 was completed with the 1119.28 close on August 8. From the key reversal on August 9 we expected to see a rally back to resistance at 1250, however since the fundamentals are not cooperating it appears there will be a test of the August 9 low at 1101.54 sooner than expected. E-mini S&P 500 Futures (ESU1) 1124.00. Volume on both Thursday and Friday was considerably more than our high volume marker of 2.5 million contracts, especially since August is a period when volume is usually lower. In addition, open interest expanded again both days, after declining last Tuesday, as the shorts dominated the market. If we see any short covering early next week, open interest should decline. S&P 500 Index Implied Volatility (IVXM). Since our last review, the Implied Volatility Index Mean has increased from 16.53 to 36.63, while the VIX increased from 19.53 to 43.05. 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.
For this short-term indicator the discount to the cash is a SPX buying signal indicating professional expectations for the cash to decrease back toward the futures price. This week at -18.93% is the second highest discount we have recorded, exceeded only by last week’s reading at -21.44%. Readings above 20% are generally a good indication of increased professional hedging in anticipation of an immediate decline while negative readings suggests complacency about protecting long stock positions by buying VIX futures contracts. Low and especially negative readings, like the current one, have been good leading indicators for short-term market advances in the past. Since the CBOE updates the VIX futures term structure during the day an estimate of the current premium is always available.  VIX Options With a current 30-day Historical Volatility of 225.11 and 145.27 using the Parkinson's range method, the table below shows 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.
Using the IV Index Mean of 122.41, the IV/HV ratio is .54, using the range method for Historical Volatility the ratio is .84. The VIX put-call ratio was .60. All of the Implied Volatilities along with the Historical Volatilities and Greeks for the VIX options based upon the Futures prices can be found on our Advanced Options page by clicking on the "market close" link shown near the top of the page. CBOE S&P 500 Skew Index (SKEW) 124.05. When out-of-the money S&P 500 Index puts are purchased for downside protection, the SKEW is designed to increase. From our perspective, the SKEW continues to act more like a contrary indicator. As an alternative method, consider the skew readings for both the SPX and the VIX below. SPX Skew -.3607 VIX Skew  .5444 Skew Spread .9051 On Monday August 8, the SPX skew was at the lowest 52-week reading at -2.0960, while the VIX was 1.9239 for a combined skew spread of 4.0199 compared to Friday's .9051.   US Dollar Index (DX) 73.99. Despite the 10-year Treasury note trading at the lowest yield in thirty years, the dollar index has not significantly increased and appears to be in a 73.50 to 76.50 trading range. iShares Barclays 7-10 Year Treasury (IEF) 104.10. With a striking similarity to the gold chart, the 10-year note looks overbought, selling at a yield of 2.07% having reached as low as 1.97% last Thursday. NYSE McClellan Summation Index -618.29. After three weeks of triple digit declines, our NYSE breadth measure stabilized last week and recorded a slight 2.70 gain, however it is still a long way from zero and even further from 1,000, which is considered neutral. iShares Dow Jones Transportation Average Index (IYT) 76.26. From a Dow Theory perspective, the transports have lost their relative strength and are leading the S&P 500 Index lower reflecting concern that the US economy is slowing. While the S&P 500 Index is still above the August 9 key reversal low, IYT is 1.18 lower than the August 9 low providing encouragement for the bears.   iShares S&P GSCI Commodity-Indexed Trust (GSG) 32.86. GSG our proxy for the CRB Index declined and closed below 32 before recovering somewhat on higher gold prices. Now in a well-defined downtrend it would need to close back above 35 to begin reversing the downtrend. Copper at 3.98, basis Sep futures, is showing noteworthy relative strength, having declined from 4.50, it is still within the recent 3.90 – 4.50 range.
Strategy After pushing risk assets lower last week, conditioned upon no further negative news from Europe, a short covering rally could be possible as the markets begin to anticipate what possible actions Ben Bernanke may announce on Friday. Ben has pulled rabbits out of his hat in the past as we reported in Digest Issue 11 on March 17, 2008 and he may well have another planned to reveal on Friday. Recall, the sentiment this time last year was also very negative. Most analytical comments so far do not expect anything new to be announced, but from a trade planning perspective it seems prudent to close some shorts and be closer to neutral by Friday. Accordingly, we suggest closing the long SPDR Gold Trust (GLD) call spread we suggested in Digest Issue 29 when it was 155.20. For those who may want to initiate new positions we have some ideas below. Based upon the premise equities will rebound early next week here is another, like the one offered last week, that would have been closed on Friday pursuant to the trade plan.   Direxion Daily Small Cap Bull 3X Shares (TNA) 36.24. This ETF seeks daily investment results, before fees and expenses, 3 times the price change of the Russell 2000 Index. The current Historical Volatility is 152.84 with an Implied Volatility Index Mean of 131.10, up from 116.19 last week. We are expecting they will both be declining back into the 80 range, the IV/HV ratio is.86 and the put-call ratio is .60.
Use a close below 34 as the SU (stop/unwind). Since even the best plan can be overwhelmed by changing fundamentals, we need a plan B. For this trade we suggest reversing the direction in the event SPX closes back below 1100 by using TZA call spreads like the one suggested in Digest Issue 29. SPDR Gold Shares (GLD) 179.95. This trust holds gold bullion. We now suggest closing the long SPDR Gold Trust Sep 157/162 call spread we suggested in Digest Issue 29 when it was 155.20. Marking it to market using Friday's closing prices it was 4.70, compared 1.84 when opened on July 18, for a 155% gain, while both time decay and implied volatility were mostly hedged. While the CME margin requirements were last raised on August 11, Interactive Brokers is advising their clients to expect another increase at any time. By most technical analysis methods gold is overbought and due for a correction. The suggestion we offered last week would have been closed out when GLD closed above 175 on Thursday, so here is a replacement. The current Historical Volatility is 18.68 with an Implied Volatility Index Mean of 26.84 and both should eventually decline back into the 15 range. The IV/HV ratio is 1.44 and the put-call ratio is a bearish at .80, but it is used for hedging so higher ratios are the norm.
Use a close above 185 as the SU (stop/unwind). Although there is no pivot or resistance to use for placing the stop, we need to limit the risk in the event it continues higher.  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.   Summary After another rapid decline last week a short covering rally should be expected before Ben Bernanke gives his speech from Jackson Hole on Friday.

In addition to the vast number of articles and other information on our web site, take a browse through our bookstore for more reference information and material.
Follow us on twitter for more ideas from our scanners and other developments.
In next week's issue, we will use our ranker and scanner tools to search for some additional interesting trading ideas.
Finding Previous Issues and Our Reader Response Request 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.

 

 

Copyright 2011 IVolatility.com
All rights reserved.

Permalink

Comments are closed for this entry.