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IVolatility Trading Digest™

Volume 12, Issue 41
Election Correction

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Election CorrectionUp until last week the correction appeared to be a normal retreat from the previous high made on September 14, but now the picture is less favorable from a technical perspective as the correction could be morphing into some more serious such as liquidation before the election. It could go either way, but we should have the answer this week.

In this issue, we update our market indicators and make the uncertainty case for the market going in either direction including a chart of the S&P 500 Index followed by a "true believer" long call spread for Apple Inc. (AAPL) before the earnings report.


Review Notes Clip ArtS&P 500 Index (SPX) 1428.59. There are two important technical concerns: first, if confirmed, is a potential double top with a measuring objective at 1388, while the second is the upward sloping trendline from the June 4 low. We have more details on the chart in the Strategy section below.

E-mini S&P 500 Future (ESZ2) 1421.50. We follow changes in the volume and open interest since a healthy trend needs open interest to continue expanding and while it declined 17K contracts from October 28 to last Thursday this decline is insufficient to conclude there has been any serious long liquidation to existing shorts who are covering.

S&P 500 Index Implied Volatility (IVXM). At the end of last week, the Implied Volatility Index Mean increased from 11.96 to 14.23, while the CBOE Volatility Index® (VIX) increased from 14.33 to 16.14.

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 Closing Cash


The day weighting applied 10% to October and 90% to November resulting in the average premium of 1.71or 10.58% shown above. Our alternative volume weighting between October and November is a 7.51% premium. Last week the day-weighted premium was 16.62%, while the volume weighted was 15.00%. The declining premium suggests less willingness to bid up the prices, although Friday's volume was 149,114 contracts and the open interest expanded to 419,966 contracts compared with the previous Friday's open interest at 407,720. The last trading day for the VIX October futures is Tuesday.

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 98.03 and 75.02 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 tradable futures.


Implied Volatility (IV) of the at-the-money VIX calls and puts


Using the IV Index Mean of 75.89 the IV/HV ratio is .77, using the range method for Historical Volatility the ratio is 1.01 while the VIX put-call ratio at .53, up from .38 last week is less bullish for VIX, but less bearish for the SPX since they move in opposite directions. Friday's options volume was 447,066 contacts compared to the 5-day average of 427,180 contracts.

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) 120.97. Designed to measure the purchase of out-of-the-money S&P 500 Index puts that would require a very large downside move to profit from long put positions, an increase of this index indicates a higher expectation of an extreme down move. Now just below the midpoint of the 114-130 range this indicator is not reflecting very much concern about a further large decline.

CurrencyShares Euro Trust (FXE) 128.71. Recently it seems all "risk on" assets, including equities, have been following the euro, which seems to have found support at 128 and may retest the upper part of the recent 130-131 range. When the euro is up "risk on" assets are also up and vice versa. The 30-day correlation function with the S&P 500 Index in our Advanced Historical Data section is now 61.11 up from 52.69 last week and 40.25 as we reported in Digest Issue 39. Further euro strength would add support for equities.

NYSE McClellan Summation Index 555.44. As the correction deepens, our NYSE Composite breadth indicator continues declining as expected. Since we last reported in Digest Issue 39, it has declined 194.44, more points with 158.60 points of the decline occurring last week. Since the momentum here is clearly downward there is no divergence.

iShares Dow Jones Transportation Average Index (IYT) 89.51. Now very close to the center of the current 86-94 range, the major market indexes will have difficulty unless this group begins improving. Declining crude oil prices could provide some cost pressure relief, while some economic indicators including the University of Michigan Consumer Sentiment Index at 83.1 are looking better. Further stimulus from China would also help stimulate global GDP.

SPDR Homebuilders (XHB) 24.62. With clear signs of profit taking in this group the question is how much lower will it go? Our upward sloping trendline from the June 4 low at 18.93 currently crosses at 23, but three recent attempts to close above 26 all failed. Using the double top measuring technique the minimum downside-measuring objective is right at 23. Any further decline below 23 implies something more than a correction, despite news of improving fundamentals in the sector.

United States Oil (USO) 34.00. Based upon the known fundamentals, other than the Middle East risk premium, it seems hard to justify WTI crude at 92, basis December futures. We continue supporting the view, that weakening seasonal demand should result in a continuation of the decline to the 30 level or about 80 per barrel for WTI crude.



StrategyWhile third quarter earnings reports should be the focus of attention this week, we noted above the questionable condition of the S&P 500 Index (SPX). Here is the current chart along with more details.


S&P 500 Index (SPX)


The upward sloping trendline (USTL) above shows the status of the uptrend that began with the June 4 low at 1266.74. If it holds this line, the addition of the third trendline point will enhance its validity. However, there is a potential double top at the highs shown above as T1 and T2. A close below the August 21 high at 1426.66, slightly below the current close, will activate the pattern and will be below the USTL. In that event, the double top will be activated with minimum measuring objective at 1388 marked MO on the chart above.

Despite the precarious technical condition of the S&P 500 Index (SPX) the VIX, the VIX futures premium, nor the CBOE S&P 500 Skew Index (SKEW) seem to reflect as much concern as would be expected, which adds to the uncertainty. We also note some other important indexes like the iShares Russell 2000 Index (IWM) 82.10 and the PowerShares QQQ (QQQ) 66.68 are still above their respective upward sloping trendlines, but declining.

Until this week, we had been saying that underinvested mutual and hedge funds would be chasing performance since they risk losing assets under management if their year-end performance lags the S&P 500 Index and that it could reach 1500 by the end of the year. Now unless SPX holds the upward sloping trendline then we will conclude profit taking is more important than chasing year-end performance.

If the decline continues, then the VIX will increase along with the implied volatility of individual stocks so consider using long straddles and strangles for the Volatility Kings listed in Digest Issue 38 and Digest Issue 40.

October Options Expiration

The regular October options will expire Saturday so the last trading day is Friday. As the market had been rising we have added more October positions than usual to the Digest portfolio so we will begin closing or unwinding them on Monday, especially if SPX looks like it will close below 1426.66.

True Believer

For the true believers who have been right for so long we have a conditional suggestion to consider.

Apple Inc. (AAPL) 629.71
Apple Inc. (AAPL)

With their earnings report scheduled for release after the close on October 25, with a consensus estimate of 8.98 per share and a whisper number at 10.02, carefully watch the closing prices early this week.

For those thinking the current correction from the September 21 high at 705.07 down to the upward sloping trendline, where it now rests is a buying opportunity, consider that it has formed a complex Head & Shoulders Top with a downside-measuring objective at 600. However, with any improving market sentiment early in the week it will likely bounce quickly off the trendline support.

In that event, here is a call spread to consider.

First, the options data.

The current Historical Volatility is 22.39 and 18.35 using the Parkinson's range method, with an Implied Volatility Index Mean of 34.57 up from 34.30 last week. The IV/HV ratio is 1.54 and 1.88 using the range method to calculate the HV. Friday's put-call ratio was in bearish territory at 1.00, while the volume was 930,259 contracts traded compared to the 5-day average volume of 872,010.


Apple Inc. (AAPL)


One of the advantages of using call spreads is the opportunity to participate trading high priced stocks with a relatively low and defined risk. For this particular suggestion, there is no volatility edge and the risk reward ratio, with the cost 44% of the distance between the strikes is not very good, but it does offer a low cost low risk way to see if it will turn higher. On the other hand if it continues lower Monday and closes below the upward sloping trendline, now at 629 we suggest deferring the trade and wait until it reaches 600, the downside-measuring objective for the Head & Shoulders Top mentioned above.

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


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The S&P 500 Index is at an important juncture going into 3Q earnings reporting. Any lower close means the correction could become something more than profit taking suggesting serious liquidation could be underway that may last into the election and perhaps beyond.


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, we will again use our rankers and scanners to find more trading ideas and we should have a good reading on the market's direction going into the election and year-end.


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. Another way to find them is the Table of Contents link in the blog section of our website.

Next week's 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



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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.

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