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IVolatility Trading Digest™

Volume 12, Issue 47
Almost Bullish

Almost Bullish - IVolatility Trading Digest

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Almost BullishWhile last week's low volume advance from the prior week's drubbing was no doubt encouraging for the bulls, we remain cautious until we see a successful retest of the S&P 500 Index (SPX) recent low of 1343.35 made on November16.

In this issue, we update our indicators and then explain why we remain cautious while offering two work in progress ideas, one an updated hedge using iShares Russell 2000 Index (IWM) and another long SPDR Gold Shares (GLD) suggestion.


Review Notes Clip ArtS&P 500 Index (SPX) 1409.15. The upward move from the key reversal on Friday November 16 continued higher closing above 1400, the previous support level that is now resistance. However, since last Friday's volume was extremely light we are reluctant to call this move a successful breach of the resistance. In the Strategy section below we detail why we suspect there will be more downside in the next few days.

E-mini S&P 500 Future (ESZ2) 1405.25. Tracking the changes in open interest over the last two weeks has not provided any additional information about the trend condition. On November 9, the open interest was 3.10 million contracts and as of Wednesday, it was only slightly higher at 3.12 million contracts. 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 reduce long stock positions.

S&P 500 Index Implied Volatility (IVXM). At the end of last week, the Implied Volatility Index Mean declined from 15.36 to 13.29, while the CBOE Volatility Index® (VIX) declined from 16.41 to 15.14.

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 85% to December and 15% to January resulting in an average premium of 1.23 or 8.09% shown above. Our alternative volume weighting between December and January is 10.93%. On the market advance last week the premium expanded somewhat and is again approaching the normal range in the low teens.

Increasing volume in both the long iPath S&P 500 VIX Short Term Futures ETN (VXX) 30.00 and the VelocityShares Daily Inverse VIX Short Term ETN (XIV) 19.06 appears to be important influences determining the VIX premium. The long VXX trades between 1.5 and 2 times as many contracts as the short, but increasing relative volume in the short XIV reduces the VIX premium from more futures contract sales. When the term structure is in contango, or it slopes upward over time, the advantage goes to the short XIV since VXX continuously sells the near term contract and buys the longer term at a higher price.

Fridays light VIX futures volume was 71,531contracts compared to the week before at 177,816, but the open interest was just slightly lower at 382,639 contracts compared to 384,448 the previous week.    

VIX Options

With a current 30-day Historical Volatility of 93.14 and 70.73 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 71.14 the IV/HV ratio is .76, using the range method for Historical Volatility the ratio is 1.01 while the VIX put-call ratio at .64, is again higher than last week at .41 making it slightly less bullish for VIX, but more bullish for the SPX since they move in opposite directions. Friday's options volume was low at 260,617 contracts compared to the 5-day average of 690,250.

The equity only put call ratio declined from .81 last week to .59, while our spread between the VIX put call ratio declined to -.05 meaning while SPX put activity was declining VIX put activity was increasing, both are bullish from a market directional perspective. However, the volume was very low.

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) 117.82. 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 indicator declines and reverses with the market contrary to expectations.

CurrencyShares Euro Trust (FXE) 128.91. After making a low at 119.73 on July 24, it was trending higher until November 2 when it gapped lower and declined to test 126. Friday's gap open and subsequent close up 1.59 points on light volume must be suspect and since it supported the equity advance, it makes the equity advance equally suspect. See the chart below.



During the low volume holiday week, equities and "risk on" assets again followed the euro. It has a reputation for advancing into yearend, but this has not been the case recently as the seasonal highs have come in October and November the last few years.

NYSE McClellan Summation Index -62.85. Although it advanced 62.13 last week, for the previous two weeks, the NYSE Composite breadth indicator declined 268.86 points. Until we begin to see breadth trending higher, and closing above zero we remain cautious on the market. 



StrategyIn Digest Issue 44, we highlighted the S&P 500 Index (SPX) close below the important 1400 support level setting off the Head & Shoulders Top with the minimum downside-measuring objective at 1327. On November 16, it reached 1343.35 before making a key reversal and then closing back above the 1400 resistance on Friday. There are several reasons for thinking it will soon retest the 1343.35 low including the low volume advance this week, and more importantly, it most always retests important lows. In the last year, there have been seven other meaningful declines - all retested within a few weeks. If this advance, wich has occurred on low volume continues without retesting it will be the exception. Therefore, from a technical perspective the odds favor a retest with the Head & Shoulders Top measuring objective down at 1327 still possible.



Now for two works in progress



Conditional Hedge Update

iShares Russell 2000 Index (IWM) 80.47

Last week's advance from the key reversal was straight up so we did not have a chance to open the hedge suggestion in Digest Issue 46. Now with a close above 80 all we need to see is a lower high and a lower low or some other indication that the current advance it stalling. We are expecting a retest of the November 16 low, but be aware it could be over quickly. If so, we will begin unwinding all of our open hedge positions.

The updated option details omitted from last week's suggestion follow.

The current Historical Volatility is 16.46 and 13.07 using the Parkinson's range method, with an Implied Volatility Index Mean of 17.13 down from 19.19 last week. The IV/HV ratio is 1.04 and 1.31 using the range method to calculate the HV. Friday's put-call ratio was bearish at 2.00, but understandable since it is a hedging favorite. The volume was 287,753 contracts traded compared to the 5-day average volume of 303,340.

The strike prices and premiums may need adjusting once again when implemented, but here is the suggestion using Friday closing prices.


iShares Russell 2000 Index (IWM)


At 22% of the distance between the strike prices, this spread has a good risk to reward ratio and a reasonable volatility edge. If implemented, use a close back above 82 as the SU (stop/unwind).


More Seasonal Gold

As we mentioned in Digest Issue 45 chances are all of the chatter about the fiscal cliff over the next couple of weeks should help to support gold, so here is another suggestion to consider.

SPDR Gold Shares (GLD) 169.61.

Here are the relevant option numbers.

The current Historical Volatility is 12.76 and 8.13 using the Parkinson's range method, with an Implied Volatility Index Mean of 12.22, down from 12.36 last week. The IV/HV ratio is .96 and 1.50 using the range method to calculate the HV. Friday's put-call ratio at .62 was just under the bearish line, while the volume was 116,314 contracts traded compared to the 5-day average volume of 125,200 contracts for the low volume short holiday week.

Consider this long call add on spread suggestion.


SPDR Gold Shares (GLD)


At 36% of the distance between the strike prices, it has a an attractive risk to reward ratio. Continue using a close back below the last pivot made on November 2 at 162.30 as the SU (stop/unwind).

Both 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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Encouraging as it was for the bulls the bounce off the recent key reversal is likely to encounter selling as the volume increases back toward more normal levels after Thanksgiving week. The odds favor a retest of the November 16 low and it could start in the next few days. Once completed we could see an advance lasting into yearend.


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You have it exactly backwards in your statement "When the term structure is in contango... the advantage goes to the short XIV since VXX continuously sells the near term contract and buys the longer term at a higher price."
When Vix is in contango, we should short VXX, go long XIV. If vxx buys the longer term contract at higher prices, there is a negative roll yield working against vxx and it will go down in contango. Just look at it since 11/9 as an example. Major error!

Posted by Wayne on November 26, 2012 at 12:37 PM EST


Thanks for correcting my XIV comment. You are exactly right; I was attempting to say a long position in the XIV is the equivalent to short VXX, but failed to state it clearly.


Posted by Jacktrader ( on November 30, 2012 at 07:33 PM EST

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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".