« June 2012 »

IVolatility Trading Digest™

Volume 12, Issue 25
Greek Yawn

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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The financial markets do not seem to have as much interest in the Sunday Greek election as the financial media. The euro was higher and the dollar lower, providing support for equities, but the yield on the 10-Year US Treasury Note declined suggesting the markets are more interested in the two-day Federal Open Market Committee meeting on Tuesday and Wednesday.   

In this digest issue, we update our indictors giving special attention the improving equity market while suggesting it is time to close out any remaining short positions in the strategy section followed by a new long idea.


Market Review

Review Notes Clip ArtS&P 500 Index (SPX) 1342.84. Last week we mentioned the destroyed flag pattern highlighted Digest Issue 23. SPX has since evolved into a new Head & Shoulders Bottom pattern, with the head at the June 4 low of 1266.74 and the neckline NL crossing at 1336 creating the new upside minimum measuring objective at 1404 marked MO on the chart. We should also mention that since the decline to the left shoulder low was very rapid there is likely be little resistance on the way back up to the measuring objective and then a subsequent retest the  May 1 high at 1415.32. It seems like equities must be anticipating QE3. 

E-mini S&P 500 Future (ESU2) 1337.50. Since the June futures contract expired Friday, the new front month is September, expiring September 21. Based upon the preliminary CME report Friday's volume appeared to be low at 1.9 million contracts creating some doubt about the breakout above the neckline on the cash chart above. However, revisions to the preliminary reports are common and occasionally they are material, especially the open interest count. We suggest checking the final CME report on Monday morning to see the volume revision, if any. It is found at the CME website under the Market Data heading, Daily Bulletin, the fifth report listed, "PG01C Summary Volume And Open Interest Index Futures And Options."   

S&P 500 Index Implied Volatility (IVXM). Since last week, the Implied Volatility Index Mean decreased from 18.75 to 18.56, while the CBOE Volatility Index® (VIX) decreased from 21.23 to 21.11.     

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 8% to June and 92% to July resulting in the average premium of 2.37 or 11.22% shown above. Our alternative volume weighting between June and July results in a 7.10% premium. Last week the day-weighted premium was 9.44% and the volume weighted was 7.36%.  

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. In the past premiums in excess of 20%, have usually preceded corrections, although not a precise timing tool it did appear to be a good way to measure professional hedging sentiment. On the recent decline, the VIX premium indicator failed to increase as expected.

Since the CBOE updates the VIX futures term structure during the day an estimate of the current premium or discount is always available. In addition, the data is available on our Advanced Futures Options pages, using VX as the Instrument symbol and CF for the exchange. Compare the options Implied Volatility to the Historical Volatility by setting HV chart to 21 days.

VIX Options

With a current 30-day Historical Volatility of 109.79 and 96.22 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 Friday's closing option mid prices along with their respective month's futures prices, since the options are priced from the futures.



Using the IV Index Mean of 98.07 the IV/HV ratio is .89, using the range method for Historical Volatility the ratio is 1.02 while the VIX put-call ratio at 1.27, is bearish for the VIX, but bullish for the SPX since they move in opposite directions. Friday's total volume was 680,583 contracts compared to the 5-day average of 456,870 contracts. Tuesday is the last trading day for the June options. 

All of the Implied Volatilities along with the Historical Volatilities and Greeks for the VIX options based upon the futures prices are on our Advanced Options page, found by clicking on the "market close" link shown near the top of the page.

CBOE S&P 500 Skew Index (SKEW) 126.08. Designed to measure the purchase of out-of-the-money S&P 500 Index puts for downside protection this index again seems out of step with the equity indexes since it increased 11.03 Friday closing above its range since mid March. Perhaps SKEW is correctly reflecting uncertainty before the Greek elections, the G20 Summit, Monday & Tuesday in Los Cabos, Baja California Sur and any possible disappointment if no QE3 announcement follows the FOMC meeting Wednesday.  

CurrencyShares Euro Trust (FXE) 125.92. After the key reversal we mentioned in Digest Issue 23 the euro advanced as expected, testing 125 where the resistance turned it back to 124 before making a comeback late in the week to close solidly above 125. While the euro is the most obvious indictor for the Greek election, many say the final outcome is not likely to result from this election.   

NYSE McClellan Summation Index -286.67. In the past two weeks, the NYSE Composite breadth index, one of the most reliable early trend change indicators, turned the corner advancing 220.63 points moving higher along with the broad market index. While the was no positive divergence that would have been created by moving ahead of the index, there is also no negative divergence if it failed to move higher as the index turned higher.

iShares Dow Jones Transportation Average Index (IYT) 91.44. The low at 87.01 made on May 18 before the rally back above 92 is now the left shoulder of a new Head & Shoulders Bottom pattern with the head being the June 4 low at 86.09. While it has not yet closed above the neckline, it is right up against it and if it should continue higher, it will set up a minimum upside measuring objective at 97.50 above both the January and March highs, most likely on expectations for lower fuel costs. 

SPDR Homebuilders (XHB) 20.23. The Head & Shoulder Top pattern, with the Head at the May 2 high of 22.43, the neckline at 19.25 with a minimum downside-measuring objective at 16.57, became active by the close below the neckline at 18.93 on June 4. Since then it rebounded to close back above the neckline, but it is lagging many of the other equity indexes that are creating well defined Head & Shoulder Bottom patterns.    

iShares S&P GSCI Commodity-Indexed Trust (GSG) 29.65. About all we can say about this energy-heavy index is that it has stopped declining, as it bounces along the 29 support level that could become the low for this cycle, if crude oil prices start advancing, which we don't expect until later in the year.




In the past week, there has been a noteworthy improvement in the equity indexes with both the S&P 500 Index and the Dow Jones Industrial Index both making Head & Shoulder Bottom patterns while the confirming Dow Jones Transportation Index is very close. In addition, many other individual issues have already made Head & Shoulders Bottoms or are also very close. However, before coming overly enthused, we note several other important indexes has not yet crossed above their necklines, including the E-mini S&P 500 September futures contract above, the Powershares (QQQ) 62.99 and the Russell 2000 ETF (IWM) 77.22 but we are anticipating they will continue higher in the next few days.   

Although there is considerable uncertainty about the outcome in Greece the equity markets seem less concerned about the never-ending elections in Greece and more focused on other events scheduled this week.

Since it appears equities are about to continue higher, this seems like this is a good time to check the contrarian sentiment indexes.

The American Association of Individual Investors Sentiment Survey for the week ending Wednesday June 13 reports the bulls at 34% with the bears at 35.8% for a net bear reading of -1.8%, but for the prior week ending June 6, the bulls were 27.4% and the bears at 45.8, making the bear spread -18.4%. The long-term average is 39% bullish and 30% bearish for a spread of +9%. As a contrarian indicator, this one seems to confirm the June 6 bottom as sentiment is improving.    

Another indicator we occasionally check to determine their bullish or bearish bias is the weekly Investors' Intelligence survey of financial newsletter writers. Although backward looking, it is considered contrarian since at the extremes it has signaled changes in trend. As of June 13, the reading was 37.2% bullish and 26.6% bearish for a bull/bear spread of 10.60%. For the week of June 6, the readings were 34 bullish and 26.6% bearish for a spread of 8.40%. This one also indicates improving sentiment from the low made the week before.

Our friends at Leavitt Brothers have a number of interesting timing indicators including one for the Nasdaq Composite Bullish % Index  using a 5-day EMA that looks quite timely. Click on the link and have a look.  

While there is still some uncertainty and downside risk if there is no QE3 announcement, the weight of evidence suggests closing any remaining long put positions and begin looking for opportunities to sell puts on selected individual issues while the implied volatility remains favorable since it will decline when they start trending upward again.

A Walk on the Long Side

SPDR S&P 500 Index (SPY) 134.14.

While acknowledging there could be a good bit of downside in the event there is no QE3 announcement from the FOMC meeting next week here is a long combination idea with a well defined stop included just in case it's needed.  

First, the relevant options data.

The current Historical Volatility is 16.57 and 14.31 using the Parkinson's range method, with an Implied Volatility Index Mean of 18.77, up from 18.29 last week. The IV/HV ratio is 1.13 and 1.31 using the range method to calculate the HV. Friday's put-call ratio was bearish at 1.50, but within the normal range of 1.50 to 1.60, since it is hedging favorite. The volume was 3,557,807 contracts traded compared to the 5-day average volume of 3,429,840 contracts.

Consider this long combination idea.



While there is a decent volatility edge in the short put, use a close below the pivot that forms the right shoulder of the Head & Shoulder Bottom pattern at 131 as the SU (stop/unwind).

The suggestion above uses the closing middle price between the bid and ask on Friday. On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.


Confused about the market?

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The improvement in equities last week was most likely due to QE3 expectations despite continuing uncertainty from Greece as most of the major indexes are making an important technical bottoming pattern providing an overall positive tone for equities.


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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".