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IVolatility Trading Digest™

Volume 13, Issue 50
Changing Picture

Changing Picture - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Changing PictureAs we prepare to close out the year with the S&P 500 Index up 29% signs are starting to appear that the world economy may be on the verge of improving thus confirming the advance has been more than just price to earnings multiple expansion. Indeed selected rising commodity prices along with interest rates could be early confirmation of an improving economic picture going into 2014.

We have more after our last market review for the year followed by suggestions for ProShares UltraShort 20+ Year Treasury (TBT) and Freeport-McMoRan Copper & Gold Inc. (FCX) that will test the stronger economic premise going into the New Year.


Review Notes Clip Art

S&P 500 Index (SPX) 1841.40. In Digest Issue 49 "Window Dressing", we noted a potential Head & Shoulders Top with a minimum measuring objective down at 1747. Since then, the upside reversal on December 18 with a 29.65 point advance followed by another 8.72 advance on December 20 to close above the potential Head cancels the potential pattern and the advance continued into new high territory once again. While not yet overbought there were some signs of profit taking in some widely followed momentum names Friday.

CBOE Volatility Index® (VIX) 12.46. Since our last review in Digest Issue 49 "Window Dressing" VIX rapidly declined as expected on the December 18 SPX taper announcement advance to reach a low of 11.69 Thursday.

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.



The day weighting applies 68% to January and 32% to February for an average premium of 12.39% shown above. Our alternative volume-weighted average between December and January, regularly found in the Options Data Analysis section on our homepage, is slightly higher at 12.66%. Premiums in the ten to twenty percent range reflect a normal Futures term structure consistent with an advancing market unconcerned with a near term decline.

VIX Options

With a current 30-day Historical Volatility of 78.59 and 62.94 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.



The relatively low Implied Volatility Index Mean (IVXM) 51.78 is below both Historical Volatility measures for a .66 ratio and .82 using the range method for Historical Volatility.

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) 80.39. Despite modest tapering announced by the Federal Reserve on December 18, the dollar continues testing the lower end of its recent range with support at 79.75 and resistance in the 81-81.50 area. Although interest rates advanced, the dollar is not yet reflecting strength and even tested the lower end of the range Friday. Perhaps the lack of strength is more about year-end euro strength than dollar weakness.

10-Year Treasury Notes (TNX) yield 3.01% above the September 5 resistance high of 2.98%. However, the dollar has yet to reflect the higher rate and key commodity prices are moving higher including WTI crude oil, and copper confirming the stronger economy scenario.

iShares Dow Jones Transportation Average Index (IYT) 131.10. Avoiding any potential divergence the transports continued advancing along with the S&P 500 Index despite higher crude oil prices adding further confirmation to the strengthening economy story.

NYSE McClellan Summation Index 233.76. After the Federal Reserve taper announcement breadth slowly began improving by advancing 40.77 points for the week ending December 20 and then another 204.43 points last week as breadth momentum picked up. However, it is still much lower than it was May 17 when the NYSE Composite was 776.83 points lower. This divergence continues to be a concern, as more money is concentrated in fewer issues. If the market begins reflecting better economic conditions, breadth should continue improving.

CBOE S&P 500 Skew Index (SKEW) 136.72. 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.

As the VIX declined after the December 18 taper announcement out-of-the-money put activity increased as SKEW advanced to a high of 143.19 on December 20 the highest level in more than a year as professional hedgers used declining implied volatility to buy some put protection for their long portfolios. At the close Friday, it was 10.50 higher than our last report.


Thanks to the taper announcement from the Federal Reserve, the market has greatly improved from a technical perspective since our last market review in Digest Issue 49 "Window Dressing" when there were signs of a potential Head & Shoulders Top pattern.

As interest rates advanced, the dollar remained in a trading range but crude oil advanced on news the International Energy Agency revised its forecast for global demand growth up for both this year and next to 1.2 million barrels per day due to a more constructive outlook for the world economy. They reported US demand is up 4% from a year ago.

With a reputation for accurately forecasting world economic growth copper broke out above 3.47 basis December Futures after a long decline despite rising interest rates adding more colour to an improving economic picture.

Although one week is not long enough to define a trend especially at the end of the year we suggest testing the hypothesis that commodity prices can increase along with interest rates as the economic picture improves. Accordingly, we have one suggestion for advancing interest rates and another for advancing copper prices. Should either fail, we must reconsider the hypothesis.

First interest rates,

Rising Interest Rates

ProShares UltraShort 20+ Year Treasury (TBT) 79.33.

Since TBT moves in the opposite direction as 20+ Year Treasury bonds it will increase along with long-term interest rates greatly simplifying the analysis.

The current Historical Volatility is 20.64 and 14.95 using the Parkinson's range method, with an Implied Volatility Index Mean of 21.83, up slightly from 21.79 last week. The 52-week low was 19.84 on November 18 while the high was 34.73 on June 24. The put-call ratio at .5 was below the bearish line, while the volume was 29,392 contracts traded compared to the 5-day average volume of 28,830 reflecting reasonable options liquidity.

Consider this long call spread idea.



In the event long rates decline again in the New Year, use a close back below the last pivot at 76 as the SU (stop/unwind), further reducing the 1.48 risk.

Copper Breakout

If world economic conditions improve then copper should continue advancing although there was a story floating around about an online Wall Street Journal article questioning the accuracy of reported inventory levels.

Freeport-McMoRan Copper & Gold Inc. (FCX) 37.50

Advancing from 34 on December 12 it is about to test resistance at 38 made on October 30. If the advance is due to expected improving economic conditions then resistance should not hold the advance very long. Here is a limited risk trade to test the continuation.

First, some options data.

The current Historical Volatility is 15.34 and 17.31 using the Parkinson's range method, with an Implied Volatility Index Mean of 23.75 up from 22.20 last week. The 52-week low was 21.20 on December 23 while the high was 43.09 on April 17. Friday's volume was 54,634 contracts traded compared to the 5-day average volume of 53,110.



Allowing enough time to test the copper breakout and resistance this is a relatively low cost strategy with a defined and limited risk. Use a close back below 34 as the SU (stop/unwind).

The suggestions above use the Friday closing middle prices between the 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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The favorable market response to the modest bond buying tapering announced by the Federal Reserve on December 18 could be the first signal that somewhat higher interest rates are a sign of improving world economic conditions as selected key commodity prices are rising along with interest rates.


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


Next week we will update the January effect results for 2103 and use our ranker and scanner tools in search of more 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.



I'm confused...If I want to go LONG...what am I looking for...amongst other things (cup-with-handle, diverging IV vs. HD, etc.):

1) Hi or Low "Correlation 30D" ?

2) Hi or Low "IV Index 30D call" ?

3) Hi or Low "IV Index 30D Hi/Low Indicator" ?



Posted by Bob on December 31, 2013 at 12:51 AM EST

Thanks for the question. It would be nice if there were only one or two things that you need to make a decision, but if that were the case then few people would want to keep their day jobs. Indeed, it requires considering many things and comparing current conditions with the past.

Referring to your list, I have not found the cup & handle pattern widely cited by Investor’s Business Daily to be very helpful. Of the classical Edwards and Magee bar chart techniques, I mostly rely upon a properly drawn trendline along with Head & Shoulders Tops and bottoms and symmetrical triangle consolidation patterns.

Diverging IV compared to HV is a measure of relative option price, i.e. inexpensive, expensive or fair valued. In general, when options are inexpensive the idea is to have more long options than short for both long and short positions. Usually however, when options are inexpensive stocks are trending higher as less put buying tends to lower the implied volatility. While high IV is normally associated with anticipation of a continuing decline, it can be a warning sign. Remember implied volatility is mean reverting so low IV will advance back toward the mean while high IV will eventually decline back toward the mean, which suggests taking the opposite position at the extremes.

Currently the Implied Volatility of the S&P 500 Index is near the lower end of its range as measured by the VIX and our Implied Volatility Index Mean (IVXM). This means long option positions are reasonably priced so you can use them for both bullish and bearish positions depending upon your directional view of the underlying.


Posted by Jacktrader on January 04, 2014 at 07:15 PM EST

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