« January 2013 »

IVolatility Trading Digest™

Volume 13, Issue 3
Trending Higher

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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Trending HigherFrom the S&P 500 Index (SPX) 1485.98 perspective the breakout and close above the September 14 high at 1474.51 confirms a new uptrend measured from the November 16 low at 1343.35 with the December 31reversal low of 1398.11 making the second point for our upward sloping trendline as shown on the chart below.

First, we update our market indicators and then follow with another iShares Russell 2000 Index (IWM) trend continuation idea.


Review Notes Clip ArtS&P 500 Index (SPX). Using the SPDR S&P 500 (SPY) 148.33, to measure the volume we see Thursday's breakout of 133.8 million shares was not very convincing since we know low volume breakouts are not reliable. Friday's volume of 169.9 was better, but volume that is more convincing would have been closer to 200 million, like January 2 on the gap up volume of 192 million. However, since the breakout is still early the volume could rise further in the next few days.

S&P 500 Index Implied Volatility (IVXM). Since our last review, the Implied Volatility Index Mean declined from 12.06 to 10.59, while the CBOE Volatility Index® (VIX) declined from 13.83 to 12.46.

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 85% to February and 15% to March for an average premium of 19.54% shown above. Our alternative volume weighting between February and March is 22.51%. The premiums over the cash VIX are now at the upper end of the normal range suggesting higher bids by professional hedgers expecting the VIX to rise when the SPX retests the breakout.

iPath S&P 500 VIX Short Term Futures ETN (VXX) 23.98. The five-day average volume was 27.04 million shares with 45.5 million on Friday as it declined 1.65 points.

VelocityShares Daily Inverse VIX Short Term ETN (XIV) 21.49. The 5-day average volume for the inverse was 10.02 million shares with the greatest volume of 11.2 million on Friday.

The declining volume of the XIV appears to be a reason for the increasing VIX futures premium. The long VXX usually trades between 1.5 and 2.5 times as many contracts as the short XIV, but declining relative XIV volume increases the VIX premium. The 5-day average was 2.70, with Friday's ratio at 4.06. 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.

Friday's VIX futures volume was 154,877 contracts while the open interest declined from 449,816 the week before to 425,822.

VIX Options

With a current 30-day Historical Volatility of 117.07 and 73.15 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 54.23 the IV/HV ratio is .46, using the range method for Historical Volatility the ratio is .74 while the VIX put-call ratio at .38 is bull for VIX, but not for the SPX with a put-call ratio of 1.50, since they move in opposite directions. Friday's options volume was 806,301 contracts compared to the 5-day average of 686,560.

The equity only put call ratio was .54 making the spread between the SPX put-call ratio and the VIX put-call ratio .16. Correcting our previous comment, a narrower spread is bullish since means the VIX put-call ratio relative to the SPX call ratio is lower. As the SPX put call ratio increases it becomes more bearish while the VIX put-call ratio is more bearish (for the SPX) as the ratio declines making the spread between them wider.

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.

iShares Barclays 7-10 Year Treasury (IEF) 107.08 Interest rates now at 1.84 have declined from 1.96 on January 4 as equities moved higher. For now there appears to be less concern that rates will continue higher after briefly testing and quickly rebounding from support at 106.50.

iShares Dow Jones Transportation Average Index (IYT) 101.39. As probably the single most important leading indicator for the economy, the transports are in a strong uptrend and now well above the previous 86-95 range. In addition to being an important Dow Theory confirming indicator the transports deserve close attention as a leading indicator especially when they breakout to the upside. Trucks move goods before retail sales occur while railroads move materials and finished goods months before consumer sales. The transports are indicating the equity uptrend will likely continue.

NYSE McClellan Summation Index 890.98. Since our last review, the market breadth indictor advanced another 357.73 points continuing higher but still lagging the NYSE Composite Index already in new high territory creating a divergence. Ideally, they should both be at new highs.

Now for the updated SPX chart.



Last Thursday's breakout to close above the September 14 high of 1474.51 sets up our new upward sloping line USTL and could be important for a potential Head & Shoulders bottom that some analysts are suggesting is active. If so, the left shoulder label is LS, the Head is H, while the right shoulder is RS. Ideally, the USTL should have more than two points and we suspect before the trend is completed more support points will be added and we are expecting to see more than 1500 before it retests the USTL.




StrategyAlthough the increasing VIX premium over the VIX cash suggests the professional hedging community is growing more cautious we think this is the time to increase long positions and accordingly have another long call spread idea for the occasion.

iShares Russell 2000 Index (IWM) 88.57. Since the smaller capitalization companies have a tendency to outperform the large companies in the early part of the year, here is another trend continuation idea to consider. While we suggested the same approach in Digest Issue 1, using February options this one going out to April allows enough time for the breakout retest.

The current Historical Volatility is 13.59 and 10.04 using the Parkinson's range method, with an Implied Volatility Index Mean of 13.24 down from 15.23 last week. The IV/HV ratio is .97 and 1.32, using the range method to calculate the HV. The put-call ratio was in bearish territory at 2.00, but it is a hedging favorite so high put-call ratios are the norm. Friday's volume was 702,821 contracts traded compared to the 5-day average volume of 422,350.



The put volatility edge offsets the lack of edge in call spread. Use a close back below the 84 support as the SU (stop/unwind) and below the USTL up from the November 11 low.

The suggestion above uses the closing middle price between the Friday bid and ask. Tuesday the option prices will be somewhat different due to the time decay over the long weekend and any price change.


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While the professional hedging community is becoming more cautious with the breakout our indictors are positive, especially the economically sensitive DJ Transportation Index. The breakout is likely to continue awhile longer before retesting the breakout.


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, we will fire up our rankers and scanners looking for more good trading ideas and may include another guest author idea.


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".