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Today


IVolatility Trading Digest™


Volume 12, Issue 43
Applesauce

More Volatility Kings - IVolatility Trading Digest

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

 

Election Correction

This week we make the case for Apple's correction being over and since the S&P 500 Index is capitalization weighted with Apple having the most influence by a significant amount, as Apple goes so will the S&P 500 Index.

We begin by updating our indicators and a brief strategy comment followed an adjustment to a previous Apple suggestion and more information about our expanded volume and open interest data along with reminder to get your complimentary copy of Simon Vine's The New Era of Investing.

 

Review Notes Clip ArtS&P 500 Index (SPX) 1411.94. An updated chart in the Strategy section below shows SPX closing below the upward sloping trendline (USTL) that began with the June 4 low at 1266.74. Since there appears to be good support at 1400, it may not reach the measuring objective at 1388 if Apple Inc. (AAPL) 604 holds support at 600. There are more details on both below.

E-mini S&P 500 Future (ESZ2) 1407.50. We follow changes in the volume and open interest since a healthy trend needs open interest to continue expanding and from the close on October 12 to last Friday's close it expanded more than 100K contracts, based upon the preliminary open interest report. Based on this we conclude there has not been noteworthy long liquidation to existing covering shorts.

S&P 500 Index Implied Volatility (IVXM). At the end of last week, the Implied Volatility Index Mean increased from 14.26 to 15.08, while the CBOE Volatility Index® (VIX) increased from 17.06 to 17.81.

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 68% to November and 32% to December resulting in an average premium of .65 or 3.66% shown above. Our alternative volume weighting between November and December is almost the same at 3.60%. Last week the day-weighted premium was also low at 3.76%, while the volume weighted was 4.76%. The low premium suggests little hedging enthusiasm to bid up the futures prices. In addition, the futures volume declined to 96,072 contracts compared to the week before at 135,194 contracts as the open interest declined from 389,616 to 361,488 contracts over the same period.

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 88.38 and 67.38 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 81.34 the IV/HV ratio is .92, using the range method for Historical Volatility the ratio is 1.21 while the VIX put-call ratio at .56, is lower than last week at .60 making it slightly more bullish for VIX, but less bullish for the SPX since they move in opposite directions. However, Friday's options volume was just 171,722 contracts compared to the 5-day average of 375,400 and 493,474 contracts the previous Friday.

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) 119.31. 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 greater expectation of an extreme down move. Once again, we see this index is just below the 122 midpoint of the 114-130 range and not reflecting much concern about a further large decline. While this indicator can also be used in a contrary manner at the extremes, we don't think this is applicable near the middle of range.

CurrencyShares Euro Trust (FXE) 128.47. Now in a range between 128 and 131, it is currently testing support in the 128 area. The 30-day correlation with the S&P 500 Index is now 66.37, compared to 68.71 the previous week. Any advance from support around 128 would continue being advantageous for equities.

NYSE McClellan Summation Index 381.60. Since we last reported, our NYSE Composite breadth indicator declined another 173.84 points as it continues downward at a steady rate without any signs of a positive divergence with the NYSE Composite that we look for at turning points.

iShares Dow Jones Transportation Average Index (IYT) 89.33. Once again, it is very near 90, the center of the current 86-94 range where it has been since June. Without a further decline in crude oil prices or further economic improvement, this closely watched Dow Theory indicator continues limiting the upside for the major equity indexes.

SPDR Homebuilders (XHB) 25.52. While it is still much higher than 23 where our upward sloping trendline from the June 4 low at 18.93 currently crosses, this ETF of housing related companies has now made four unsuccessful attempts to close above 26 where there is considerable resistance. Any decline below 23 would imply a change of trend, which seems unlikely as more companies in the sector are reporting improving results. For now it looks like a 24.30 - 26.35 trading range.

United States Oil (USO) 31.79. We still have the opinion there are ample crude oil supplies available and unlike this time last year, crude oil has been declining since September 14. Last year the three-month futures roll had a slight backwardation of -.12 indicating tightness in the market compared to the current 1.59 contango, which seems to confirm the adequate supply notion. We continue to think, based upon the known fundamentals, other than the Middle East risk premium, it seems hard to justify the current WTI price at 86, basis December futures. Weakening seasonal demand should result in a continuation of the decline to about the 30 level or near 80 per barrel for WTI crude. Any further decline should help the transports and consumer discretionary spending.

 

Strategy

StrategyHere is an updated chart.

Daily OHLC Chart

 

The multipoint upward sloping trendline (USTL) above shows the uptrend status that began with the June 4 low at 1266.74. This changed on October 19 with the close below the trendline at 1433.19. Now using the double top from the T1 and T2 highs shown above as we calculate the minimum measuring objective to be 1388 marked with the small arrow and the 1388 M in the right margin.

With the dotted line, we also show considerable support at 1400 from August. If Apple were to turn higher, we think this support line would probably hold.

As the earnings reports come in there seems to be a distinction developing between those multinationals with extensive overseas operations and the more domestic companies. This quarter could mark the return of professional stock picking compared to the macro "risk on" or "risk off" that has been a feature of the markets for quite awhile.

If Apple turns higher and SPX holds the 1400 support, which most of our indicators above suggest, we could still see the year-end rush by underinvested mutual and hedge funds chasing performance resulting in 1500 before the year is over.  

 

 

Apple Inc. (AAPL) 604.00

After reporting 4Q earnings of 8.67 compared to a reduced consensus estimate of 8.85 the stock tested the 600 support level from last July, trading as low as 591 before reversing to close down 5.54 on 36.4 million shares the highest volume since last April, as the bulls and bears pushed and shoved. The next earnings report will be for 1Q ending December with a consensus estimate of 13.59, scheduled to be released around January 22.

In Digest Issue 41, we said it had formed a complex Head & Shoulders Top with a downside-measuring objective at 600, which it reached Friday and then reversed to close higher.

Here are the updated option statistics.

The current Historical Volatility is 27.49 and 22.48 using the Parkinson's range method, with an Implied Volatility Index Mean of 28.93, down from 41.85 last week before the earnings report. The IV/HV ratio is 1.05 and 1.29 using the range method to calculate the HV. Friday's put-call ratio was just bearish at .80. As an indication of Friday's struggle the volume was 1,574,471 contracts traded compared to the 5-day average volume of 850,170.

In Digest Issue 41, we made a conditional suggestion, to defer the trade until it reached the downside-measuring objective for the Head & Shoulders Top at 600, but since it moved higher the next day the suggested December 635/640 call spread was booked with a debit of 2.47. The mark-to-market value is now 1.48 resulting in a .99 loss if closed.

Here is the suggested adjustment based on the upward reversal continuing,

 

Apple Inc. (AAPL)

 

Combining the adjustment with the original position results in a new long December 630/640 call spread at 4.09, which is not a great risk to reward ratio, but not too bad considering we currently have a .99 loss position.

For those who waited for the 600 support level before taking the trade suggested in Digest Issue 41 this spread suggestion has a much better risk reward ratio of more than 2:1.

Use a close below the 600 support as the SU (stop/unwind). In the event it closes below 600 on Monday defer the trade and close the original trade from Digest Issue 41.

Adding to last week's news about adding both daily volume and open interest to the data tables at our complimentary Basic Options, Advanced Options and Advanced Historical Data pages we have more information. Located to the right of the stock volume, users can now easily compare volume and open interest against the one-week averages, making it easier to identify active option activity going into an earnings report, a takeover rumor or other events.

Since Advanced Options also provides intraday data, the previous day’s volume and open interest continues displaying until updated after the close each day and available when clicking on the "market close" link. To make the comparative data even more useful we include one-week averages on the Advanced Options "Close" page while the Advanced Options "Live" page shows one month averages. 

Updated in the evenings after the close they will be available before the market opens the next day. For the Advanced Options Close page, the update occurs around midnight for Advanced Options Live the new data appears later, but before the next day open.

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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.

 

"Options data with predictive qualities - Nobody does it better!"

"The best volatility charts in the business."

 

Summary

There is reasonable chance that the recent decline may be about over, especially if Apple holds its 600 support since this will improve the chances for the S&P 500 Index holding support at 1400. This week we should know if Apple is as solid as it appears or if it is about to become applesauce.

 

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.

 

Twitter Follow us on twitter for more ideas from our scanners and other developments.

 

In next week's issue, we will again use our rankers and scanner to identify more 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. 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.

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".