« December 2011 »

IVolatility Trading Digest™

Volume 11, Issue 48
Euro Indifference

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Last Friday, with the financial markets waiting in nervous anticipation, the European leaders delivered a carefully crafted message from Brussels that they had reached an historic agreement to draft a new treaty intended to create closer economic integration in an effort to confront the sovereign debt crisis. In response, the markets seemed to have reacted with a yawn since it was not enough to excite either the bulls or the bears. Consequently, traders will most likely revert to considering the usual seasonal year-end trading strategies. After reviewing the most relevant of our market indicators, we offer another year-end volatility trade idea followed by another quarterly report suggestion.


Market Review

S&P 500 Index (SPX) 1255.19. Last week after the right shoulder had been defined by the rally, we made the case for the formation of a potential Head & Shoulder Bottom. A close above the neckline at 1,350 would be required to activate the pattern that would have an estimated potential upside minimum measuring objective at 1,545. While we admit this may be just an exercise in wishful thinking we see similar bottoming patterns forming in many of the leading stocks.

E-mini S&P 500 Futures (ESZ1) 1258.75. Based upon the preliminary CME report Friday's volume was 3.6 million contracts, substantially above the average, but since the contract expires at the end of the week, the increase is most likely due to the normal contract expiration surge as positions are being rolled over from December to March.

S&P500 Index Implied Volatility (IVXM). Since our last market review, in Digest Issue 46, the Implied Volatility Index Mean declined from 31.44 to 23.45, while the CBOE Volatility Index® (VIX) declined from 34.47 to 26.38.

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.



The day weighting applied 28% to the December contract and 72% to January resulting in the average premium of 2.51 or 9.52% shown above. An alternative volume weighting between December and January results in a 7.47% premium.

For this short-term indicator the premium to the cash is a SPX sell signal suggesting professional expectations for the cash to increase toward the futures price. Last week the premium was 4.99%, compared to premium of 1.11% in Digest Issue 46, our last market review based upon November 25 closing prices. Although the higher premium could be related to the substantial 13.76% decline in the VIX on Friday, the premiums over cash have been rising for three weeks, indicating a higher level of professional portfolio hedging activity. However, this time last year the premium was 20.85%.

Since the CBOE updates the VIX futures term structure during the day an estimate of the current premium or discount is always available.

VIX Options

With a current 30- day Historical Volatility of 142.54 and 79.68 using Parkinson's range method, the table below shows the 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, since the options are priced from the futures.



Using the IV Index Mean of 82.89, the IV/HV ratio is .58, using the range method for Historical Volatility the ratio is 1.14 while the VIX put-call ratio at 1.45 is normally bearish for the S&P 500 Index, but could indicated active put selling in anticipation of a lower VIX going into year-end. This would be consistent with the SPX skew between the calls and puts, with the call-implied volatility at 24.10 compared to the puts at 22.80.

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.

CurrencyShares Euro Trust (FXE) 133.20. Since the market is focused upon the euro, we will use FXE as our currency indicator. Liquidity fluctuating between the euro and the dollar is the primary force behind the rotation out of "risk-on" positions, such as equities and commodities into "risk-off" alternatives, such as Treasury notes and bonds. Although there have been many rotations in the last year, over the longer term the euro appears to be near the middle of its range between 1.20 and 1.50. See the chart in the strategy section below. Currently in a decline, it looks oversold so there could be a rally into the year-end and perhaps extending into the first few weeks of 2012. 

NYSE McClellan Summation Index 237.50. After a substantial decline the week before the NYSE breadth improved last week so the net change from Digest Issue 46 is -58.80. However, remember 1000 is considered to be neutral so the current reading appears tepid, but consistent with a rangebound market.




Trading strategies based upon macro fundamentals continue to be a challenge since the fundamentals remain uncertain and many of the technical indicators are equally indecisive. The outlook for the European economy is unknown and the market reaction the news on Friday reflects apathy. From a longer-term perspective, the euro looks to be near the middle of a trading range supporting the view that the fundamentals remain uncertain.



Now just below the range midpoint defined by the green lines at 1.20 and 1.50, it currently looks oversold with a potential small double bottom pattern, making a year-end rally a good possibility. If so, a somewhat stronger euro should translate into a weaker dollar helping to support equities, assuming "risk-on" continues to follow a lower dollar.


Seasonal Implied Volatility

Following up on the suggestion made last week in Digest Issue 47 here is another seasonal volatility suggestion as a replacement for those who may have closed out last weeks' idea on Thursday with the VIX close above 30.

The seasonal tendency for equities to rise at the end of year is accompanied by a seasonal decline in implied volatility. With the 13.76% decline on Friday it looks like The VIX is headed lower.

CBOE Volatility Index® (VIX) 26.38.

Here is a calendar spread alternative for the expected continued decline in volatility. If volatility continues to decline then the spread between the futures should increase as the January futures will decline faster than the February futures.

The December futures expire on December 21, (not December 16) so this suggestion uses January and February options in an effort to capture the decline that should extend into late December and early January.

The options vital statistics are in the VIX Options section above.

Consider this spread.



Once again, use a close back above 30 as the SU (stop/unwind).


Quarterly Earnings Report

Here is another in our continuing series of earnings report ideas.

Dave's Corner

Negative RIMM Sentiment Creates Upside Opportunity Before Earnings

Research In Motion Ltd. (RIMM) 16.46.

It has been a very difficult year for Research In Motion, as products such as its PlayBook tablet have been very disappointing pushing the stock down by more than 75% in 2011. The BlackBerry maker is scheduled to report quarterly results on Dec. 15 after the bell. The consensus estimate is 1.21 per share, while the whisper number is 1.24 per share. While it is hard to imagine it could get any worse for RIM, many analysts believe there are still more headwinds ahead.

Citigroup analysts published a list of the top 10 reasons why things could get worse for the Canadian technology company. Some include the potential for delays in its QNX product launch initially scheduled for early calendar 2012 along with a decline in sales growth, which is expected to be less than half of the industry’s smart phone growth rate.

The stock price has fluctuated between a 52-week high of 70.54 and 15.98 and is currently trading near the 52-week low. Resistance is near the December highs at 18.77, with support at 16.00.

The current Historical Volatility is 54.61 and 43.30 using the Parkinson's range method, with an Implied Volatility Index Mean of 72.50, down from 80.76 last week. The IV/HV ratio is 1.33 and 1.67 using the range method to calculate the HV. The put-call ratio is bearish at .88.

With so much negative sentiment, look for a surprise upward move after the report.



The December 19 calls were bid .15 each on Friday so the total for two is .30 shown above.

With only one trading day before the options expire, the position will need to be managed. There is risk it breaks below support at 15.98. In the unlikely event it closes below 14, be prepared to take the stock by assignment. In that event, the plan is to sell calls against the long stock position.

The prices for the VIX suggestion above are based upon last Friday's closing prices using the mid price between the bid and ask. The RIMM suggestion is based on the bid price for the sales and the offer price for the purchase. On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.

As the holiday season approaches, we are again offering special discounted rates on our data services. Here is more information about how to acquire your customized data service to help find those special volatility events and other advantageous trading ideas.



IVolatility’s Holidays Special Offer



The market reaction to Fridays' news from Europe was hardly enthusiastic, insufficiently positive for the bulls; it was equally uninspiring for the bears. As a result, volatility should continue declining into early 2012.


IVolatility.com Bookstore  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.

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In next week's issue, our last for the year, we will offer more trading ideas from our ranker and scanner analytical tools.


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.

Next week’s issue


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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".