« December 2015 »

IVolatility Trading Digest™

Volume 15 Issue 49
U.S. Dollar & Crude Oil

U.S. Dollar & Crude Oil - IVolatility Trading Digest™

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As the dust settled from last week’s noteworthy events including the ISM Manufacturing report Wednesday, ECB comments Thursday, Janet Yellen’s comments, the nonfarm payroll report and the OPEC meeting, equities were almost unchanged. For those using a weekly time frame for analysis the S&P 500 index gained .08%, but on a daily basis the picture was quite different declining 1.44% Thursday and then gaining 2.05% Friday. There is more below in with our regular bi-weekly review highlighting the U.S. Dollar Index and crude oil followed by a timely iShares Silver Trust ETF article from our friends at Alpha Trader.


Review NotesS&P 500 Index (SPX) 2091.69 gained 1.58 points or .08% for the week after wild gyrations Thursday and Friday. While the double bottom upside measuring objective at 2172 remains the upside target, Thursday’s decline changed the slope of the potential more sustainable upward sloping trendline from the September 29 low at 1871.91, activated if and when it closes above the previous November 3 high of 2116.48. For now, it remains just a potential upward sloping trendline. However, in the event of a close above the November 3 high it is unlikely to reach the upside objective by yearend as suggested last week in Digest Issue 48 "Seasonal Preview [Chart]" since the trendline would have a flatter slope after Thursday’s decline.

CBOE Volatility Index® (VIX) 14.81 down .31 based on real-time prices of options on the S&P 500® Index, constructed to reflect investors' consensus view of future (30-day) expected stock market volatility. However, like SPX above the net change masks an 2.20 point advance to 18.11 Thursday before declining 3.30 Friday to end at 14.81.

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.




With 7 trading days until the December monthly expiration, the day weighting applied 35% to December and 65% to January for a 14.37% premium shown above. Our alternative volume-weighted average between December and January regularly found in the Options Data Analysis section on our homepage was slightly lower at 12.36 %.

While day-to-day VIX changes offer little forecasting insight following the VIX futures premium helps since it measures expectations of tactical professional traders and money managers using VIX futures and options for hedging long portfolio risk.

Premiums for normal term structures during uptrends are 10% to 20% while premiums above 20% are unsustainable suggesting a lack of enthusiasm for VIX hedging often occurring around market highs suggesting overbought conditions associated with pullbacks. Alternatively, premiums less than 10% suggest caution and negative premiums indicate oversold conditions. Last week the volume-weighted premium began at 6.92% Monday then declined to 1.60% in red zone Thursday before recovering to 12.36% Friday back in the green.

VIX Options

With a current 30-day Historical Volatility of 128.26 and 113.13 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.




Compared to the current range historical volatility of 113.13 both December and January at-the-money options are inexpensive relative to recent movement of the VIX futures. Friday VIX futures traded 270,887 contracts compared to just 81,309 the week ending November 27 while options on the futures traded 493,615 contracts compared to 227,880 the week before.


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.


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Foremost Six Update

As prominent members of our Foremost Six and the most important last week, here is an update for this seemingly inseparable pair.

US Dollar Index (DX) 98.35 down 1.67 points or -1.67% was the driver of the bus last week. In Digest Issue 45 "Employment Rebounds", we commented that the overbought dollar was putting downward pressure on both crude oil and gold.

Thursday’s sudden 2.37 point decline illustrates just how overbought it had become as there was sudden rush for exit when the ECB failed to meet the market’s expectations for more QE prompting quick euro short covering sending the U.S. dollar lower. Anticipating the upcoming interest rate increase by the Federal Reserve markets have been overweight dollars and short euros expecting to unwind positions on the rate high announcement. Here is a link to an excellent Thompson Reuters article along a cleverly prepared graph showing previous dollar declines on rate hike announcements. If so, a return to the October 15 level around 94 would likely support crude oil futures prices along with other commodities especially gold and silver.


oilUnited States Oil (USO) 12.46 as a proxy for WTI Crude Oil declined .57 or -1.05% for the week as the January WTI futures declined 1.74 or - 4.17% closing at 39.97. Of the 1.74-point decline, 1.10 occurred on Friday after the OPEC news.

In a Saturday statement by Dr. Ibe Kachikwu, the OPEC President, said “Next year, we foresee a growth of 1.3 million barrels per day to average 94.1 million barrels per day, with most of this growth coming from non- Organisation [sic] for Economic Co-operation and Development (OECD) countries.’’ The statement said that as far as supply was concerned, non-OPEC countries would continue to see significantly reduced production growth as compared to past years and that the downward trend would stem mainly from the impact of investment cutbacks and the drop in U.S. tight oil output, which had been on the decline since May 2015.

There is unlikely to be a meaningful cut back in US production until hedges start rolling off producer’s books thereby materially reducing cash flow. What analysis focused solely on supply and demand fundamentals misses is the role hedge demand plays in the price equation. Since crude oil prices are determined in the “paper” futures market, the raising dollar has reduced inflation hedge demand for crude oil futures. Should the dollar stabilize or reverse course after the Federal Reserve finally announces a long awaited interest rate increase and accumulated long dollar positions unwind, inflation hedging in the crude oil futures market will likely return. The added demand would be like firing a double barrel shot gun as shorts cover and new longs open. Last Thursday’s quick decline of 2.37% by the US Dollar Index (DX & DXY) could have been a preview for further declines after the rate hike announcement as explained above.


U.S. Dollar Sensitivity

Adding further support to the overbought dollar premise here is an article from our friends at Alpha

oilTraders Buy Large Blocks of Calls in the iShares Silver Trust ETF

iShares Silver Trust ETF (SLV) 13.87 up .41 or +3.05% for the week after gapping up at the open Friday is an exchange-traded fund seeking to track the movement in the price of silver. The ETF has been weak this year amidst declining silver prices falling over 8% year to date. Last week as the dollar fell after the ECB announcement, SLV gapped higher as options traders expect this move to continue for the next 2 weeks.

Early in Friday’s trading session a trader bought 6,966 December 14 strike calls for .19 when the market was .18-.19. Labeled an opening position with only 2 weeks left until expiry it represents an aggressively bullish trade.

This was the largest block to trade Friday requiring 135,354 capital. Later in the session, traders added to the position buying another large block of 4,256 contracts for 23 cents. By the end of the day, 27,453 December 14 strike calls traded with total SLV options volume tracking over twice the average daily options volume.

Since this bullish order flow is short dated, it likely represents the belief that the U.S. dollar could continue lower thereby boosting commodity prices. These are relatively low priced options so traders risk no more than their cost and it can be reduced further placing a stop limit at 50% of the initial cost. With SLV approaching a break of its area high for the month, traders are likely playing a low risk strategy hoping for a large upside move.

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Editors Note: With only two weeks to expiration, these calls may also represent a hedge against other options or a short SLV position or other commodity positions and not necessarily new long commitments.


strategySince the seasonal odds still favor an advance into yearend consider long strategies with defined and limited risk in large capitalization liquid market leaders with high options volume and narrow bid/ask spreads as short-term momentum strategies. In addition, the odds favor a dollar decline on the upcoming interest announcement that will likely support oversold commodities such as crude oil, gold and silver. Accordingly think about a hedged USO position like the one last week Digest Issue 48 "Seasonal Preview [Chart]" with enough time to get beyond the seasonally weak December - January period and should benefit if crude oil turns higher as the dollar declines as expected.


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Assuming the US dollar declines on the December 16 interest rate hike announcement as expected, the S&P 500 Index should continue higher into yearend with the added support from oil and gas companies and others in the commodity sector. However, after last Thursday’s sudden decline, the rate of advance will likely slow creating doubt that the double bottom upside measuring objective at 2172 can be reached before yearend.


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We now offer daily trading ideas from our RT Options Scanner before the close in the News section of our home page based upon active calls and puts with increasing implied volatility and volume.


For next week’s issue, we will fire up the rankers and scanners looking for new interesting trade ideas.


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