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IVolatility Trading Digest™

Volume 12, Issue 49
Low Volume Profit Taking

Low Volume Profit Taking - IVolatility Trading Digest

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Low Volume Profit Taking For those of us attempting to understand market movements we propose yearend profit taking, before a likely capital gains tax rate increase next year, along with "fiscal cliff" uncertainty producing a wait and see attitude, are the two best explanations for the recent low volume up drift among others floating around.

In this issue, we update our market indicators along with a short strategy comment about closing hedge positions followed by some interesting new Apple Inc. (AAPL) suggestions from an experienced well-known contributing author.


Review Notes Clip ArtS&P 500 Index (SPX) 1418.07. Although the "fiscal cliff" chatter denominates the financial media and is becoming more prevalent in the mainstream media as well, selected "risk on" assets continue drifting higher on low volume despite serious profit taking in those equities that have recorded hefty year to date gains. Although the probability remains high there will be a retest of the November16 1343.35 low, at some point, for now we should go with the flow.

E-mini S&P 500 Future (ESZ2) 1416.00. Since a healthy trend needs open interest to continue expanding, the uptrend from the November low of 1340.25 when option interest was 3.10 million contracts seems to be in good shape as it closed last Thursday at 3.16 million contracts. From here until after the December contract expires, it will be more difficult to use open interest as an indicator since the open interest will now surge prior to contracts rolling over into March.

S&P 500 Index Implied Volatility (IVXM). At the end of last week, the Implied Volatility Index Mean increased from 13.92 to 14.47, while the CBOE Volatility Index® (VIX) increased slightly from 15.87 to 15.90.

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 35% to December and 65% to January resulting in an average premium of 5.64% shown above. Our alternative volume weighting between December and January is 4.10%.

iPath S&P 500 VIX Short Term Futures ETN (VXX) 29.44

VelocityShares Daily Inverse VIX Short Term ETN (XIV) 19.25

Increasing volume in both the long VXX and the short XIV appears to be important influences determining the VIX premium. The long VXX trades between 1.5 and 2.5 times as many contracts as the short XIV, but increasing relative XIV volume reduces the VIX premium as more futures contract are sold. When the term structure is in contango, or it slopes upward over time, the advantage goes to a long XIV position since it represents a short futures position and VXX continuously sells the near term contract and buys the next longer term at a higher price.

Fridays VIX futures volume was 111,107 contracts compared to 106,563 the previous Friday while the open interest increased from 385,333 contracts to 395,593.   

VIX Options

With a current 30-day Historical Volatility of 79.31 and 65.59 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.



Using the IV Index Mean of 66.71 the IV/HV ratio is .84, using the range method for Historical Volatility the ratio is 1.02 while the VIX put-call ratio at .34, is much lower than last week's .69 making it less bullish for VIX, but more bullish for the SPX since they move in opposite directions. Friday's options volume was substantial at 497,462 contracts compared to the 5-day average of 432,580.

The equity only put call ratio was .64 making the spread between the SPX put call ratio and the VIX put call ratio .30. A wider spread is bullish since means the VIX put call ratio relative to the SPX call ratio is lower.

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) 115.23. 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 near the lower end of the 114-130 range it seems to confirm the lack of interest for OTM put buying.

CurrencyShares Euro Trust (FXE) 128.36. After advancing to 130, it is sitting on 128, the previous support line. Since further progress on the European debt issues are not likely until after the first of the year, the direction is now more likely to be determined by technical trading. Although it has not been the case in the last few years, since the seasonal highs have come in October and November, and it is currently near the upper part of the recent range, it does have a reputation for advancing into yearend, which would further support "risk on" assets, including equities.

NYSE McClellan Summation Index 274.78. Although slowing somewhat this week the two-week advance was 337.63 points, and it appears to be trending higher, an encouraging sign for the bulls.



StrategySince it most always retests important lows, we continue to think the S&P 500 Index (SPX) will retest the November 16 low at 1343.35. In the last year, there have been seven other meaningful declines - all retested within a few weeks. If this low volume advance continues without retesting it will be the exception. However, since the timing is uncertain there seems to be no reason to continue paying the cost of hedging.

For the record, we closed our 4 December hedges for an average loss of .35, with a low of .20 and a high of .57. Since they have long bias, we plan to hold the remaining 3 December positions until expiration.

iShares FTSE China 25 Index Fund (FXI) 38.41

On remarks by the new Communist Party leader Xi Jinping, FXI broke out above 38 and is now in a well-defined uptrend from the September 5 low at 32. Since FXI has good options volume, longer-term call spreads could work well. 

Now for Apple

Last week in Digest Issue 48, we mentioned contacting other options strategist at the recent Traders Expo and extending invitations to contribute some new ideas.

Accordingly, we are extremely pleased to present some Apple ideas from Dan Sheridan, a well-known and respected options mentor and instructor for the CBOE.

Dan is a 22-year veteran CBOE market maker. Since leaving the pits in 2004, he has been teaching individual traders on the techniques and methods he used every day to consistently profit in the options markets. From Sheridan Mentoring he teaches professional and retail traders while hosting the weekly CBOE TV show Options safari at CBOE.com. He frequently presents educational webinars for the CBOE and many brokerage firms. Further, the CBOE sponsors the popular one-day "Real trading with Dan Sheridan" seminars across the country.

Apple Inc. (AAPL) 533.25.

3 trade ideas in AAPL - Friday close $533

The personality of AAPL has changed quite a bit in the last 2½ months. The stock is currently at $533, down 24% from its September 19 close of $702. During that same period, implied volatility has skyrocketed! Comparing at-the-money calls approximately 30 days from expiration, IV was 24 September 19 and today is currently at 39! Is it time to yell, "Sell Mortimer, Sell!" As in life as well as options, you can't have your cake and eat it too! Implied volatility levels have exploded because the stock has declined and gyrated wildly with much speed. That is the key, implied volatility acts up much more when there is speed, especially on the downside. I think there may be a few opportunities in AAPL options depending on your price and implied volatility outlook over the next month.

Opinion #1: I think AAPL has found a bottom here and the stock will be a little less volatile and more range bound going into the holidays.

Strategy: Iron Condor - Buy 1 January 600 call, and Sell 1 January 570 call, then Buy 1 January 490 put and Sell 1 January 520 put. The total credit is $16.50 ($1650) while the total risk is $13.50 ($1350).

Rationale: If the IV decreases 2 points over the next 16 days, the price range, within 1 standard deviation would be roughly $503-$590. Within this range we could make anywhere from 2% to over 25% on our risk or margin. Outside of this range exit the trade for a small loss or adjust it. I would look to be out of this trade in 14-16 days looking for about 10-12% profit target. If the price moves under $503 or over $590, I would exit and live to play another day.

Opinion #2: I think the stock will rally into January earnings!

Strategy: Bullish Call Butterfly - Buy 1 January 560 call and Sell 2 January 580 calls, then Buy 1 January 600 call. The total debit is $2 ($200). The maximum loss is limited to cost of the butterfly, $200. The profit potential could reach over $1600 if we landed at the short strike of $580 on the January expiration.

Rationale: If I think the stock can rally into earnings, January implied volatility will decrease and this butterfly will really expand. During the life of the butterfly, we can get a very wide profit area. However, as we get towards expiration, it narrows. If the IV decreases even 1 point over the next 20 days, the butterfly can make between 20-70% between $540 and $627, excluding commissions. This is an extremely wide range. My plan would be to hold it no longer than 20 days and look for at least a 30% profit on my initial cost.

Second Strategy for opinion #2: Reverse Calendar - Buy 1 January weekly $535 call that expires on January 4 and sell 1 January $535 call, expiring January 18. The total credit is $5.20. I would only do this in a portfolio margin account, since in a normal Reg. T account the excessive margin requirement makes this trade much less desirable.

Rationale: This is similar to a long straddle in that we would make money if the stock moved away from the short $535 strike in either direction. The difference versus a long straddle is that we would benefit if the implied volatility decreased, which would probably happen on the upside. What we don't want to happen is for the stock to hang around the short strike of $533, since it loses money. The way I would trade this is to take off the trade if it moves $30 in either direction. This is a more advanced speculative strategy and again, I would only trade this in a portfolio margin account.

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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While a retest of the November 16 low is overdue, there is no indication it is going to arrive any time soon. Accordingly, we are closing our hedge positions until we see the retest begin, which could be after the New Year or maybe after new "fiscal cliff" news. In the meanwhile, China appears to be trending higher.


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, the last for the year, we will review some volatility basics offering some observations.


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