« November 2013 »

IVolatility Trading Digest™

Volume 13, Issue 45
Smooth Sailing

Smooth Sailing - 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).


6 Costly Options Mistakes to AvoidIn this Digest issue, we offer some trading suggestions while testing the proposition using our indicators that equities will continue smooth sailing from here until year-end.

As we do, keep this timely thought in mind.

"Never sell a stock, because it seems to high-priced."
Jesse Livermore



S&P 500 Index (SPX) 1798.18. Since market breadth has been lagging the advance, we had been looking for a modest correction of about 3% for the last two weeks. However, with the move above the 1775.22 resistance, if there is to be a correction between now and year-end it will be from a higher level. Look for support at the previous resistance high of 1775.22 with the next support down at the September 19 high at 1729.86. As for market breadth, it finally turned higher Friday after declining four days last week. The third support is our upward sloping trendline from the June low, now 1679.02, about 6.6% lower.

CBOE Volatility Index® (VIX) 12.19. Those relying exclusively on this indicator for a sense of market direction should be delighted since VIX declined from 13.28 in the last two weeks, now approaching the August 5 low of 11.84 and the March 14 low of 11.05.

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 8% to November and 92% to December for an average premium of 16.80% shown above. Our alternative volume-weighted average between November and December, regularly found in the Options Data Analysis section on our homepage, is slightly lower at 11.49%. Both premium measures are in the normal range relative to the cash VIX, confirming the sanguine market outlook.

VIX Options

With a current 30-day Historical Volatility of 119.84 and 76.19 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.



For all of those subscribing to the reversion to the mean theory, take note as the VIX and our Implied Volatility Index Mean approach their previous lows.

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) 80.78. In Digest Issue 43 "Running Out of Gas" we were not yet ready to declare the dollar downtrend had ended, but now after several closes that are clearly above the downward sloping trendline from the July 8 high of 84.75, the trend has changed. No doubt, some of the advance is normal seasonal strength going into yearend that could also be related crude oil weakness due to increased US production, boosting the dollar. Now at resistance around 81 we think the trend is now higher, which will add further downward pressure on commodities, but helping consumer sectors.

10-Year Treasury Notes (TNX) now yield 2.70% having closed above our downward sloping trendline from the 2.98% high on September 5. The 13 basis point advance on November 8 following the better than expected October employment report dispelled any uncertainty about a change of trend from lower to higher. Higher interest rates equates to a stronger dollar and weaker commodity prices.

iShares Dow Jones Transportation Average Index (IYT) 128.89. The Dow Jones Transports have been outperforming the S&P 500 Index since the middle of September much to the delight of the Dow Theory followers. Lower crude oil prices along with the October employment report are two reasons the transports continue higher led by FedEx (FDX) 138.65 and the airlines such as Delta (DAL) 28.12 and Jet Blue (JBLU) 8.78 all with good options volume and liquidity. Consider long call spreads.

NYSE McClellan Summation Index 393.55. Since our last market review in Digest Issue 43 "Running Out of Gas", our preferred market breadth indicator declined 176.53 points with 70.28 points last week including a 13.33 gain on Friday the first gain all week. In Digest Issue 44 "Relative Strength Update", we said a correction of about 3% was likely until SPX closed above 1775.22, which occurred last Wednesday, along with improving market breadth. While better on Friday, the advance thus far has been weak so further gains are needed to sustain the market advance.

CBOE S&P 500 Skew Index (SKEW) 133.46. 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.

After advancing to 135.41 on October 24, it retreated to 118.69 on November 6 before reversing upward once again. Previously we suggested relatively inexpensive OTM puts are favored for hedging and this seems to be case. For example, here are some selected samples from many for both SPX and SPY illustrating the extent of OTM put activity.

Selected S&P 500 Index put activity on Friday November 15 for puts expiring December 21



Now here are some samples for the smaller S&P 500 Index ETF, the SPY.



There was substantial volume in most all of the OTM strikes and the open interest shows serious money is committed to these puts. However, it is difficult to tell the net amount hedged due to spreading activity.

While there was extensive volume in earlier expirations as well, the December 21 expiration was most noticeable - probably related to year-end portfolio insurance strategies.


In Digest Issue 43 "Running Out of Gas", we suggested the best strategy was to remain long while extending any long November option expirations out to December, anticipating a near term correction that did not happen. Now based upon our indicators, except for SKEW, our contrarian friend as detailed above, it looks like all green lights since momentum in November, the second best performing month for the past 20 years, will likely be more important than fundamental valuations or macro concerns.

In the current low implied volatility environment, we continue suggesting long call strategies using spreads with more long than short options, especially on stocks with good options volume like those in Digest Issue 44 "Relative Strength Update." Alternatively, there are some special situations where implied volatility remains relatively high due to uncertainty such as the upcoming Linn Energy (LINE) 29.95, shareholder vote on the merger with Berry Petroleum (BRY) 51.29, scheduled for December 16, four days before December options expire.


Free Report: 6 Costly Options Mistakes to Avoid

Discover six common options mistakes that can cost you a fortune. Boost your profits instantly by avoiding mistakes that trip up most investors. Special Report - PLUS 1 month FREE subscription to Schaeffer's Option Advisor letter. Download today!



IVolatility Mobile is a must-have app for all active option traders.

Check implied volatility while on the go.

Download the free IVolatility Mobile app now



Due to last week's advance, a minor correction that we had been expecting looks like it may not occur before year-end as most all of our market indicators are positive and November is usually the second best month of the year. If there is an unexpected pull back, we suggest it would represent 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 again refer to our ranker and scanner tools in search of more interesting trade ideas.


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.



Comments are closed for this entry.

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".