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Today


IVolatility Trading Digest™


Volume 13, Issue 10
Onward and Upward

Onward and Upward - IVolatility Trading Digest

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

 

Onward and UpwardAs the equity markets opened last week, the direction outlook was uncertain as we wrote in Digest Issue 9 they were poised to go in either direction. The answer came Tuesday as the S&P 500 Index (SPX) 1551.18 gapped higher on the open, closing convincingly above the previous high made on February 20 at 1530.94. Now with no overhead resistance, we expect it to continue advancing higher.

In the strategy section below, we have some additional details in support of our bullish outlook along with a few words of caution, followed by an update for United States Oil (USO), new uptrend ideas for iShares MSCI Japan Index (EWJ) and American International Group, Inc. (AIG) along with a high IV/HV ratio idea for InterOil Corporation (IOC).

 

Strategy

Strategy

In Digest Issue 8, we said the correction could take the S&P 500 Index (SPX) back to 1480 or even back to the breakout around 1460. Since then the picture has changed, especially after it broke out of the symmetrical triangle continuation pattern last Tuesday. Ideally, the breakout should have been on higher volume, but then it advanced every day last week and the volume expanded somewhat by Friday. As a show of relative strength, the reversal low of 1485.01 made on February 26 is important since it means this pullback did not decline enough to test the active upward sloping trendline. Support is now at the February 20 high of 1530.94 while the only possible resistance is the old October 11, 2007 high of 1576.09.

While keeping in mind the 10% correction that began last April 3 on news reports the economy was slowing, be on the lookout for any key reversal made with increasing volume. It could indicate another attempt to test the upward sloping trendline since the economy could experience another slowdown this spring as sequester spending cuts gain momentum and possibly roll back the recent employment gains.

S&P 500 Index Implied Volatility (IVXM). Last week the Implied Volatility Index Mean decreased from 12.50 to 10.22, while the CBOE Volatility Index® (VIX) decreased from 15.36 to 12.59.

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 applies 28% to March and 72% to April for an average premium of 16.87% shown above. Our alternative volume weighting between March and April is 14.23%. The premiums have returned to the normal range as the futures prices declined across the term structure last week.

iPath S&P 500 VIX Short Term Futures ETN (VXX) 21.63. The five-day average volume was 46.6 million shares down substantially from 84 million the week before as enthusiasm for VIX hedging waned.

VelocityShares Daily Inverse VIX Short Term ETN (XIV) 22.12. The 5-day average volume for the inverse was 15.5 million shares compared to 23.7 million the week before making the VXX/XIV ratio 3.00.

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 contract at a higher price. The current spread between March and April is -1.27 compared to the previous week when it was -.53.

 

 

United States Oil (USO) 33.05.

Updating the suggestion we made in Digest Issue 9 last week, we now think the bottom has likely been made for USO since it is highly correlated to equities and it closed Friday above 33, the SU (stop/unwind) level we set in the most recent USO trade plan. Accordingly, we now suggest closing any remaining open bearish put spreads.

 

IVOLopps™

Trending Ideas

iShares MSCI Japan Index (EWJ) 10.47.

In a well-defined uptrend from the November 14 low of 8.75, EWJ could continue higher as the economic fundamentals improve in Japan from the implementation of widely announced monetary stimulus actions by the Bank of Japan.

The current Historical Volatility is 14.83 and 8.14 using the Parkinson's range method, with an Implied Volatility Index Mean of 17.11, down from 18.62 last week. The IV/HV ratio is 1.15 and 2.10 using the range method to calculate the HV. Friday's put-call ratio at .50 was bullish while the volume was 9,329 contracts traded compared to the 5-day average volume of 10,050.

Consider this synthetic long combination.

 

 

Based upon the historical volatility EWJ moves slowly, but when considering the current uptrend we think it could reach 12 by the June options expiration in 103 days, in the meanwhile this combination hedges both time decay and volatility risk as shown above in the Theta and Vega columns, while allowing enough time to reach the price objective. Use a close back below the last pivot at 9.90 as the SU (stop/unwind).

American International Group, Inc. (AIG) 39.58.

Here is another one in the uptrend category with improving fundamentals that is also a reported favorite of several long hedge funds.

The current Historical Volatility is 24.44 and 22.57 using the Parkinson's range method, with an Implied Volatility Index Mean of 23.18 down from 25.45 last week. The IV/HV ratio is .95 and 1.03 using the range method to calculate the HV. Friday's put-call ratio at .45 was bullish while the volume was 106,697 contracts traded compared to the 5-day average volume of 57,350.

Consider this long call spread.

 

 

Since the is no volatility edge gained by selling either the April or May 37 put there is no reason to use the margin, which would reduce the estimated return on investment if it reaches the 44 price objective by May expiration based upon the slope of the current trendline that began November 14 at 30.64. Use a close back below the last pivot at 37 that would also be below the current upward sloping trendline as the SU (stop/unwind).

High IV/HV Ratio

In the "Rankers and Scanner" section of our home page we feature the "Top 5 stocks by implied volatility change". Click on the link and you are taken to the Advanced Ranker Sample of the top and bottom 5 stock in four categories. For ideas, we often look at the Top 5 stocks based on IV Index Mean vs.30D HV.

High IV/HV ratios are the first alert that something unusual is happening as options prices are being bid up to abnormal levels. From there a little more investigation will usually provide the answer as to the likely direction.

Here is an idea from the number one highest ranked IV/HV ratio scan on Friday.

InterOil Corporation (IOC) 77.68.

This Papua New Guinea integrated oil and gas company engaged in the exploration, appraisal, and development of crude oil and natural gas has appeared on our radar screens many times in the past with high-implied volatility. Since the next earnings report is scheduled for May 29, this is not the most likely reason for the elevated implied volatility.

Since the current price is now near the center of its 52-week range it seems to be a good Iron Condor candidate since it is not trending.

First the option vital statistics.

The current Historical Volatility is 46.89 and 53.92 using the Parkinson's range method, with an Implied Volatility Index Mean of 101.02 down from 107.45 last week. The IV/HV ratio is 2.15, the highest in our Friday scan and 1.87 using the range method to calculate the HV. Friday's put-call ratio at .78 just bearish while the volume was 27,039 contracts traded compared to the 5-day average volume of 14,770.

Here is the short call spread at the top of the range, at resistance.

 

 

Next, the short put spread near the bottom, but at support.

 

 

Using the 30-day historical volatility, we calculate a one standard deviation to be 63.97 and 91.42 just about right. The risk is 2.67, the width of one of the spreads or 5.00, less the 2.43 credit received. On the presumption is closes within the range at the April expiration we will retain the 2.43 credit received. While the margin requirement is large at 1,665 it still represents a 15% gain in 40 days.

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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Summary

The breakout to the upside last Tuesday resolved the open question about the near term direction for equities. Now since there is no overhead resistance where they should encounter a lot of selling, the path seems to be onward and upward for the near term.

 

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 check on the progress of the current uptrend by reviewing our indicators.

 

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 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".