« March 2013 »

IVolatility Trading Digest™

Volume 13, Issue 9
Mighty Dollar

Mighty Dollar - IVolatility Trading Digest

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Special Limited Time OfferLast weeks' media chatter about sequestration and the anticipated effects of reduced spending seemed to be overlooking the dollar as it increased against the currencies that make up the US Dollar Index, especially Friday, the first day of implementation. If exchange rates move primarily in response to news that alters expectations about the future economic environment, as theory proposes, then less government spending is good for the economy. We expand on this a bit more while reviewing our market indicators. Then after a brief strategy comment, we have another put spread idea for United States Oil (USO).



Review Notes Clip ArtS&P 500 Index (SPX) 1518.20. Two weeks ago in Digest Issue 7, we noted waning momentum had increased the probability that the long overdue retest of the January breakout was near. Since then it declined and quickly rebounded almost back to the highs of 1530.94 made on both February 19 and 20 perhaps forming an early symmetrical triangle continuation pattern. Another possible interpretation is a small Head & Shoulders Top that would be negated with a close above 1530.94 thus confirming the continuation pattern. Another couple of weeks of bull and bear struggling should provide the answer.

S&P 500 Index Implied Volatility (IVXM). Since our last review two weeks ago, the Implied Volatility Index Mean increased from 10.28 to 12.50, while the CBOE Volatility Index® (VIX) increased from 12.46 to 15.36.

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 48% to March and 52% to April for an average premium of 8.50% shown above. Our alternative volume weighting between March and April is 8.00%. As we noted in Digest Issue 7 when the day-weighted average was 17.45%, rising premiums suggest increased professional hedging activity that seems to have peaked at just under 20% before the futures were bid higher closing the gap with the cash VIX as the SPX declined.

iPath S&P 500 VIX Short Term Futures ETN (VXX) 24.33. The five-day average volume was 84 million shares up substantially from 51.8 million last week and 31.5 million in Digest Issue 7 bidding VXX higher, which in turn pushes the futures prices higher toward the cash VIX narrowing the spread.

VelocityShares Daily Inverse VIX Short Term ETN (XIV) 19.81. The 5-day average volume for the inverse was 23.7 million shares making the VXX/XIV ratio 3.55 the highest in many weeks.

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 -.53 compared to the week before when it was -.82 and -1.12 in Digest Issue 7, our last market review.

VIX Options

The current 30-day Historical Volatility was 134.96, up substantially since last week when it was 88.53 and 69.03 in Digest Issue 7. Using Parkinson's range method, the comparable historical volatilities measures were 92.51, 60.34 last week, and 50.13 in Digest Issue 7, all reflecting the increased movement. 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 79.38, the IV/HV ratio is .59, using the range method for Historical Volatility the ratio is .86. The VIX put-call ratio at .53 is bullish for VIX, but not for the SPX with a put-call ratio of 2.00, up .20 for the week, since they move in opposite directions. Friday’s options volume was 507,806 contracts compared to the 5-day average of 721,980.

The SPX equity only put-call ratio was .74 making the spread between the SPX put-call ratio and the VIX put-call ratio .21. 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.

CBOE S&P 500 Skew Index (SKEW) 128.19. 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 7, we noted it was above 130 and when it previously ventured above this level, such as September 21, 2012 it preceded a market decline. The close at 130.46 on February 15 as reported in Digest Issue 7 turned out to be valid sell signal once again. It is now in the upper quartile of the 113-130 range and heading higher. We suggest watching for any additional closes above 130.

US Dollar Index (DX) 82.31. The dollar began advancing on rumors that the Fed would end monetary easing early, but last week when the rumors were mostly dispelled by Chairman Bernanke, the dollar continued higher, this time apparently in response to implementation of the sequester that will begin reducing government spending. The dollar strength took its greatest toll on commodities, including crude oil, gold and copper. In the past, dollar strength was also negative for equities, but if it begins to reflect better economic conditions, weaker commodity input prices should eventually be positive for equities other than raw material producers. In the meanwhile, equities are working on resolving their overbought condition as we described above.

iShares Dow Jones Transportation Average Index (IYT) 106.51. Correcting along with the SPX the transports are approaching an important crossroad. One is a potential double top implying a meaningful decline if set off by a close below 103. The other interpretation has it back to the center of its upward channel thus implying the advance will continue higher. A close above the previous high of 107.46 will confirm the advance alternative. In addition to being an important Dow Theory confirming indicator, the transports deserve close attention as a leading economic indicator.

NYSE McClellan Summation Index 873.74. Since our last market review two weeks ago in Digest Issue 7, the breadth indictor declined another 175.21 points with 92.84 of them last week providing the best argument that the equity decline is likely to continue lower. Breadth needs to start improving for a sustained healthy resumption of the equity uptrend. So far, this is not the case.



StrategyIn Digest Issue 8, we reported the trend change in "Downhill Momentum" and suggested the correction could take S&P 500 Index (SPX) back to 1480 or even back to the breakout around 1460 on the presumption the sequestration babble would become unusually rancorous. Well the babble was indeed rancorous, but equities seemed unconcerned advancing back up near their previous high. As noted above there are currently two alternatives, one is a small Head & Shoulders Top that could take SPX back toward 1460 and the other is a symmetrical continuation pattern that would override the Head & Shoulder Top interpretation on a close above 1530.94. In the meanwhile, the dollar strength is pushing commodities lower and this seems like the way to go for now.

United States Oil (USO) 32.74.

Last week in Digest Issue 8, we suggested two put spreads for USO. For the week, it declined .86 points after consolidating in the early part of the week, but pushed sharply lower Friday on the dollar strength.

Using the closing prices, we booked the March 33.5/31 put spread last Monday for a .68 debit; Friday it was .88 for a 29% mark-to-market gain. The April 33.5/31 put spread was booked for .81; Friday it was .99 for a 22% mark-to-market gain.

Using the range historical volatility of 13.20 as the input for our probability calculator, we calculate a one standard deviation to the March expiration at 31.90 on the downside and 31.17 for April. Since we are expecting it to decline to our minimum measuring objective (MO) of 31, described in Digest Issue 8 last week, we realize that it is likely to require more time if it continues declining at the current rate. Accordingly, we are going add one more May suggestion.

First the updated options statistics.

The current Historical Volatility is 15.40 and 13.20 using the Parkinson's range method, with an Implied Volatility Index Mean of 22.00, down from 22.17 last week. The IV/HV ratio is 1.43 and 1.67 using the range method to calculate the HV. Friday's put-call ratio at 1.38 was bearish while the volume was 74,416 contracts traded compared to the 5-day average volume of 51,520.



The .76 debit is 30% of the distance between the strike prices meaning the risk to reward is 2.3 to 1 at the 30 short strike. Use a close back above 33 as the SU (stop/unwind). In the event it opens above 33 Monday defer the trade.

The suggestion above uses 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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While it is clear the equity correction is underway, what has yet to be determined is how for it may go, especially since dollar strength in the past has not supported higher equity or commodity prices that are now under pressure.


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Can you clarify your HV/IV comparison please? In the IV Digest you compare HV to the IV Index Mean; today you use the 30HV for comparison on Vix options. I understand the IV mean to also be 30 days; however, the HV is 30 TRADING days while the IV is 30 CALENDAR days. Can you confirm that – and comment on that comparison. I notice that on other occasions, you compare the 20HV to IV; that seems to be a better comp to me as 20HV is about 1 calendar month.

I also have a question on VIX, SPX IV and month 1 VIX futures:
The VIX is a calculation based on the implied volatility of a normalized 30-day SPX option (a weighted blend of the first two months of S&P 500 options). I understand that your 30 day IV index is a mean – but if it’s a 30 day IV of SPX and VIX is a 30 day IV of SPX options, why aren’t their values normally be closer together?

Thanks! I appreciate your work!

Posted by Wayne Wolberg on March 04, 2013 at 03:48 PM EST


Thanks for your questions. Yes, the calculation for IV uses 30 calendar days. As for using 20 or 30 days for the HV calculation we offer them both as some prefer 20. In addition, we compute other periods as well, such as 10, 60, 90, 120, 150 and 180. Since we use 30 day HV for our charts where they are compared to the IV we usually refer to this period. Both work just fine, but the 20-day will of course lead the 30 day.

As for comparing the SPX IV to the VIX the difference is due to the calculation method. The original VIX was calculated from eight near-term at-the-money S&P 100 (OEX) call and put options using the Black-Scholes options pricing model. In 2003, the calculation was changed to use the at-the-money and all out-of-the-money S&P 500 (SPX) calls and puts. Our IVX uses a proprietary weighting technique that includes the Delta and Vega of four ATM options for all expirations. While the results vary slightly they are highly correlated.

The one month VIX Futures are determined by the market so they are completely different, except at the expiration settlement when the VIX and VIX Futures come together.


Posted by Jacktrader on March 06, 2013 at 01:12 PM EST

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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".