« November 2012 »

IVolatility Trading Digest™

Volume 12, Issue 45
Golden Hedge

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Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Golden Hedge

With breakdowns below key support levels for both the S&P 500 Index (SPX), PowerShares QQQ (QQQ), along with several others, the time has come to get busy increasing hedge positions while adding a new SPDR Gold Shares (GLD) to the book.

Since the near-term direction seems clear, a review of all our market indicators seems needless, so we begin with an abbreviated review, followed by two put spreads suggestions and a long call gold spread.


Review Notes Clip ArtS&P 500 Index (SPX) 1379.85. Previously SPX closed below the upward sloping trendline (USTL) that began with the June 4 low at 1266.74, then last week it closed below the important 1400 support level setting off the Head & Shoulders Top with the minimum downside-measuring objective at 1327. Since Friday's key reversal up is unlikely to be important for more than a day or two and we are expecting to see the minimum objective fulfilled before this decline is completed.

E-mini S&P 500 Future (ESZ2) 1375.75. Lately our focus on open interest has been too narrow since we missed highlighting the peak that occurred on September 14 at 3.4 million contracts coinciding with the recent price high. Now, including the increase on November 7 as the index closed below 1400 on large volume, the open interest was slightly above 3 million contracts based upon the preliminary report. We follow changes in the volume and open interest since a healthy trend needs open interest to continue expanding since a decline suggests short covering by large funds no longer needing as much hedging as they begin reducing long stock positions.

S&P 500 Index Implied Volatility (IVXM). At the end of last week, the Implied Volatility Index Mean increased from 15.36 to 16.97, while the CBOE Volatility Index® (VIX) increased from 17.59 to 18.61.

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 28% to November and 72% to December resulting in an average premium of .71or 3.82% shown above. Our alternative volume weighting between November and December is somewhat less at 2.15%. Last week the day-weighted premium was even lower at 3.56%, while the volume weighted was 3.12%. Despite the decline of the SPX below 1400 on large volume, this indicator is not showing as much premium to cash as seen in previous periods of decline. The low premium suggests less hedging enthusiasm using VIX futures, while the volume is somewhat less but still substantial at 128,566 contracts compared to the week before at 142,901 contracts as the open interest declined from 377,862 to 375,058, but in the recent normal range.

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 94.54 and 68.14 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 88.26 the IV/HV ratio is .93, using the range method for Historical Volatility the ratio is 1.30 while the VIX put-call ratio at .44, is higher than last week at .27 making it slightly less bullish for VIX, but more bullish for the SPX since they move in opposite directions. Friday's options volume was 305,336 contracts compared to the 5-day average of 339,303.

Last week in Digest Issue 44, we noted Larry McMillan's comment that the equity only put call ratio gave a sell signal about a month ago when SPX made the second test of the high that formed the potential double top. Larry says the trend of the ratios is rising and any further continuation is bearish. Friday it was .82 as it continued rising from .77 the previous week.

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) 115.40. 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. Now approaching the lower end of the 114-130 range this seems baffling, as we would expect to see it rise as SPX declines.

NYSE McClellan Summation Index 206.01 For the previous two weeks the NYSE Composite breadth indicator declined another 175.59 points continuing lower along with the index without any signs of a positive divergence that we look for at turning points.



StrategyAfter the Apple Inc. (AAPL) 547.06 drubbing along with some other recent momentum favorites it is becoming apparent profit taking in anticipation of higher capital gains tax rates in involved. There are several companies in the consumer discretionary sector due to report this week and if tax selling is a factor then those with large year to date gains should be most vulnerable.

Since we are expecting the decline to increase, we suggest employing more hedging strategies using sector ETFs or individual stocks.

More Hedging

PowerShares QQQ (QQQ) 63.43. In Digest Issue 42, we offered a hedge conditioned upon a close below support at 65 and last Wednesday it fulfilled the condition, so here is an updated version.

The current Historical Volatility is 15.88 and 12.97 using the Parkinson's range method, with an Implied Volatility Index Mean of 18.87, up slightly from 18.26 last week. The IV/HV ratio is 1.19 and 1.45 using the range method to calculate the HV. Friday's put-call ratio at .85 was bearish while the volume was 578,692 contracts traded compared to the 5-day average volume of 396,720.


PowerShares QQQ (QQQ)


With a slight volatility edge, the debit is 29% of the width between the strike prices giving it a favorable risk to reward ratio. Use a close back above 65, the prior support, now resistance, as the SU (stop/unwind) in the event the decline is near completion.

The Home Depot, Inc. (HD) 60.96.

With respectable recent gains, it looks vulnerable to selling after reporting 3Q earnings on Tuesday before the opening. The consensus estimate is .70 per share with a whisper estimate of .73 per share.

Although it advanced on Sandy news, it did not exceed the now broken upward sloping trendline from the July 23 low at 49.77. While any extra earnings due to Sandy will not be included in this report, no doubt management will make some comments. Further, the housing sector seems to be slowing in what may only be a seasonal decline, but a decline nevertheless.

With a weak market, there are many put spread alternatives available, but this one also has good options volume making it easier and less costly to implement spreads.

Since they report Tuesday before the opening, it needs doing today.

Here is the options data.

The current Historical Volatility is 19.98 and 16.00 using the Parkinson's range method, with an Implied Volatility Index Mean of 23.17, up from 22.64 last week. The IV/HV ratio is 1.16 and 1.45 using the range method to calculate the HV. Friday's put-call ratio at 1.80 was very bearish before the earnings report while the volume was 17,870 contracts traded compared to the 5-day average volume of 16,410.


The Home Depot, Inc. (HD)


With a good volatility edge and only 16% of the distance between the strike prices, it has a very attractive risk to reward ratio, but it is a long way out-of-the-money and there is support right at 57.50. Use a close back above the most recent pivot at 62.50 the SU (stop/unwind).

Seasonal Gold

Seasonal Gold

While it certainly did not happen last year, there is a seasonal tendency for gold to rise from early November through December that occasionally extends into January. However, the euro is also a factor since dollar strength is not friendly to gold, but there will be a lot of chatter about the fiscal cliff over the next few weeks, which will add to the uncertainty, and could add support for gold.

SPDR Gold Shares (GLD) 167.82.

When we last suggested a gold trade in Digest Issue 35, it was advancing from the July lows. Now after correcting we think there a reasonable chance it could resume the advance and eventually exceed the October 4 high of 174.07.

Here are the relevant option numbers.

The current Historical Volatility is 12.80 and 8.05 using the Parkinson's range method, with an Implied Volatility Index Mean of 14.53, down from 14.70 last week. The IV/HV ratio is 1.13 and 1.81using the range method to calculate the HV. Friday's put-call ratio was right on the bearish dividing line at .70, while the volume was 168,563 contracts traded compared to the 5-day average volume of 245,770 contracts.

Consider this long call spread suggestion.


SPDR Gold Shares (GLD)


With a slight volatility edge and good risk to reward ratio, use a close back below the last pivot made on November 2 at 162.30 as the SU (stop/unwind).

All of the suggestions above use 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 November 7 decline eliminated the last ray of sunshine for the bulls and now most all of the major indexes appear headed lower for the immediate future, with gold being one of the possible exceptions.


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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".