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Today


IVolatility Trading Digest™


Volume 13, Issue 41
Washington Reprieve

Washington Reprieve - IVolatility Trading Digest

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Washington ReprieveAfter endless quibbling, finally a temporary deal emerged from Washington to reopen suspended government activities through January 15, 2014, while postponing the need for any further debt limit authorization until February 7.

While it is not all clear skies and smooth sailing for equities, since some clouds still remain on the horizon, it does open the window enough for higher equity prices until year-end presuming 3Q earnings reports are constructive.

In this issue, we update our indicators along with our operative equity chart and provide commentary from our options perspective.

 

Review Notes Clip ArtS&P 500 Index (SPX) 1744.50. After two closings below the upward sloping trendline, the October 9 Key Reversal marked the low for the recent politically induced correction. After a quick recovery, it even continued higher after the agreement confirming news last Wednesday taking the index to a new high by the end of the week and in the process created a new two point upward sloping trendline from the November 16 low at 1343.35. We have an updated chart in the Strategy section below.

CBOE Volatility Index® (VIX) 13.04. The 3.70 decline from our last review in Digest Issue 39 "No Jobs Report", takes VIX back to just below where it started a month ago before the market turned its attention to Washington as if to say, "We're glad that's over, now let's get back to work."

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 88% to November and 12% to December for an average premium of 10.87% shown above. Our alternative volume-weighted average between November and December, regularly found in the Options Data Analysis section on our homepage, is slightly higher at 12.69%. Both premium measures have recovered substantially putting them back into the more normal range between 10-15% relative the cash VIX, thus confirming last week's market advance.

VIX Options

With a current 30-day Historical Volatility of 130.88 and 78.04 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.

 

 

Since our last review in Digest Issue 39 "No Jobs Report", the call front month implied volatility declined from 107.58 to 63.07 while the puts declined from 111.75 to 54.07 as the volume increased to 1,079,494 contracts although the October options expired last Wednesday. At week's end, the open interest was 6.1 million contracts compared to the five-day average of 7.6 million, another positive indication for the bulls.

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.

US Dollar Index (DX) 79.65. The dollar's decline below 80 on Thursday reflects the 10-Year Treasury note yield decline. We still think there is a reasonable chance the dollar will hold around the 80 level especially since the delayed employment report due Tuesday could cause some selling of Treasuries presuming the report reflects continuing economic improvement, which seems likely considering favorable comments made by some reporting companies last week.

10-Year Treasury Notes (TNX) now yield 2.58% after reaching as high as 2.98% before the August employment report on September 6. Our active upward sloping trendline begins at the low of 1.62% made on May 3, touching the August 12 low at 2.60%. For now, the trend continues lower, but we think support around 2.65% or resistance around 102 using the iShares Barclays 7-10 Year Treasury (IEF), will likely hold on the employment report.

iShares Dow Jones Transportation Average Index (IYT) 122.00. As we noted last week in Digest Issue 40, "Volatility Kings 3Q Update", the important transport index tested, but did not close below its upward sloping trendline from last June on the last correction perhaps reflecting economic improvement fueling more speculation the Tuesday employment report will confirm continuing progress with a good jobs number.

NYSE McClellan Summation Index 257.65. Since our last update in Digest Issue 39 "No Jobs Report", our market breadth indicator declined 23.89 despite advancing 134.23 last week. Like some of our other indicators, this one seems to be making a short-term round trip, down on the political wrangling but now rebounding to the upside. We expect it will now continue higher confirming the index new highs.

CBOE S&P 500 Skew Index (SKEW) 131.35. SKEW measures the purchase of out-of-the-money S&P 500 Index puts that require a very large downside move to profit from long put positions. An increase of this index indicates greater expectations for an extreme down move.

In Digest Issue 39 "No Jobs Report", we noted the recent unusual rise of this index when it was 123.98. Now 7.37 higher than last week and .89 higher than the previous high of 130.46 made February 15, it suggests increased out-of-the-money put buying. Looking back at the February 15 high we see the S&P 500 Index began a 3% correction February 20, five days later, suggesting there is some value using SKEW as a contrary indicator when at extremes like now.

 

The strategy to hold a few relative strength stocks suggested in Digest Issue 38 "Options Relative Strength Top 15" despite the then developing warning signs seems to have paid off as this group quickly rebounded after the political agreement in Washington. Now at another new high we should consider the rebound came too quickly creating the conditions for another correction of say 3%, like the one in February, to bring the index back to a more sustainable advance rate. Here is the updated S&P 500 Index chart with the new upward sloping trendline, USTL.

 

 

We define our new operative upward sloping trendline by the November 16 low at 1343.35 and the most recent correction low that occurred with the Key Reversal low of 1646.47 on October 9. With a 303.12-point advance in 327 days, we calculate the slope at .93 per day. Now we can easily compare the current closing price to the USTL by adding .93 per day to 1646.47 to get 1654.84 for the USTL compared to the 1744.50 closing price. If the SKEW put buyers are right like they were in February then we can expect to see a correction back to about 1700 perhaps triggered by a positive employment report that causes selling in various Treasury issues that could let some air out of the equity bubble.

Without further political hindrance from Washington, chances are good the market advance will continue into year-end after a brief correction to the current overbought condition, providing an opportunity to increase long positions in relative strength issues like those in Digest Issue 38 "Options Relative Strength Top 15." Consider long call spreads and since implied volatility has declined, call ratio backspreads, consisting of more long options than short options where all options expire at the same time.

 

 

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Summary

While equities declined during the political squabbling in Washington, they quickly rebounded on the first hint that an agreement was at hand and then continued even higher on the confirming news. While they now appear overbought, any minor correction should provide a buying opportunity for year-end positioning.

 

Twitter Follow us on twitter for more ideas from our scanners and other developments.

 

In next week's issue, we will update our Options Relative Strength list.

 

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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