« October 2016 »

IVolatility Trading Digest™

Volume 16 Issue 41
Between a Rock and a Hard Place [Charts]

Between a Rock and a Hard Place [Charts] - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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While the traditional risk indicators declined last week, there could be more to the story as the declining euro increases macro risk for both crude oil and equities explained below after a brief market review including our regular look at the VIX futures premium along with VIX options data. Then The Blue Collar Investor offers some strategy thoughts about trading earnings reports.

Review NotesS&P 500 Index (SPX) 2141.16 gained 8.18 points or +.38% for week as support at 2120 appears to have held the decline from the rising wedge described last week in Digest Issue 40 "Rising Wedge and Kings Update." After making an intraday low of 2114.72 on October 13, it quickly made an intraday high the next day at 2149.19 defining another smaller rising wedge that appers underway. Should this one develop in a similar manner the measuring objective would be around 2115, just below current support at 2120.

VIXCBOE Volatility Index® (VIX) 13.34 down 2.78 points or -17.25% and back to where it was two weeks ago after reaching an intraday high of 17.95 on October 13 – One week Risk Off, the next Risk On.

According to the CBOE, based on real-time prices of options on the S&P 500® Index, VIX reflects investors' consensus view of future (30-day) expected stock market volatility.

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 17 trading days until the November monthly expiration, the day weighting applied 85% to November and 15% to December for a 17.85 % premium shown above. Our alternative volume-weighted average between October and November regularly found in the Options Data Analysis section on our homepage was slightly higher at 19.30% while the open interest weighted premium was 18.80%.

The premium measures the amount the futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration. Depending on the time to expiration, premiums for normal term structures during uptrends are 10% to 20% and decline when the VIX advances faster than the nearest future as the market declines and/or the futures decline as the front month expiration approaches. Premiums less than 10% suggest caution and negative premiums indicate oversold conditions when the VIX is higher than the futures and are usually associated with reversals.

This week the premium appears normal for Friday after October expiration. For example, after the September expiration the premium was 28.59% reflecting both time to October expiration, along with higher futures bids suggesting more hedging activity. In addition, this week volume declined to 178,810 contracts with 438,675 contracts of open interest compared to 283,406 contracts traded with 508,099 contracts of open interest the week before.

VIX Options

The current Historical Volatility of 132.44 and 128.41 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 closing option mid prices along with their respective month’s futures prices, since pricing of the options are from the tradable futures.




Compared to the current range historical volatility of 128.41 both November and December at-the-money option prices are inexpensive relative to the recent movement of the VIX futures as usual as shown in the volatility chart.




Here comes the macro bus

DollarBusUS Dollar Index (DX) 98.70 gained .68 point or .69% for the week, after breaking out above 97.50 on October 11. While some part of the strength is about expectations for a December interest rate hike the more significant development last week was euro weakness.





Here is the euro ETF chart.




Once € closed below 1.07 on October 14 the bottom fell out and gold turned noticeably higher versus the euro explaining why gold advanced along with DX. Then, Thursday Mario Draghi said quantitative easing is unlikely to come to an “abrupt” end. Amazingly, the FX market seemed to know the previous Friday 10-14, see the arrow above.



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Crude OilWTI Light Sweet Crude Oil (CL) 50.85 basis December futures advanced .10 points or +.2 % for the week after reaching an intraday high of 52.22 on Wednesday October 19 and then retreating back near support at 50.


The weekly Commitments of Traders reports from the CFTC as of Tuesday October 18 provides insight into the activity of the participants that determine the market reference price of crude oil, using the Disaggregated Commitments of Traders - Options and Futures Combined as explained in Digest Issue 31 "Rounding Top & Crude Oil [Chart]."

A "money manager," for the purpose of the COT report, is a registered commodity trading advisor (CTA), a registered commodity pool operator (CPO), or an unregistered fund identified by CFTC. So called “hedge funds” are included in this category, regardless of whether they are registered. With the most at risk at turning points, changes in the net long position of this "Managed Money" group usually correlate the best with crude oil price changes.

The Managed Money net long position, now at 11.22% of the open interest, up from 3.35% on 8-2-16 when WTI cash was 39.49, arrow below. Of equal importance it is now at its highest level since 7-29-14 when it was 12.65% and WTI cash was 98.22




The other important group, "Producer/Merchant/Processor/User" (PMP), are entities predominantly engaged in the production, processing, packing or handling of a physical commodity and uses the futures markets to manage or hedge risks associated with those activities. As a group PMP, reduced their shorts by 48,628 contracts, but sold 45,895 for a net position increase of 2,733 contracts.

Managed Money and PMP, arguably the only two groups that really matter in the price tug of war, seem to be thinking alike.


"If everyone is thinking alike, then somebody isn’t thinking." – General George S. Patton Jr.


However, since crude oil and the US Dollar Index, DX & DXY have a tendency to move in the opposite direction, a declining euro increases risk as DX raises putting crude oil between a rock and hard place as they say. In addition, since the S&P 500 Index has been following crude oil a rising DX also decreases support for equities.

Trading Earnings Reports

One of The Blue Collar Investors’ most important covered call writing rules is not to sell a covered call option if the underlying stock is reporting earnings prior to contract expiration. Since many companies report during the upcoming November contracts, (now through November 18, 2016), finding those not on the report schedule can be a challenge. With a basket of stocks, Exchange Traded Funds (ETFs) offer one solution since the risk of large moves on earnings reports are of less concern as positive and negative report moves usually cancel out.

Here are 3 ETF ideas to consider.

iShares MSCI Brazil Capped (EWZ)

VanEck Vectors Semiconuctor (SMH)

SPDR S&P O&G Exploration & Production (XOP)

From the "multiple tab" on the Ellman Calculator:




The average 1-month return from option premium is 2%, annualized to 23.6%.

The average 1-month share appreciation potential from current price to the strike price (option agreed upon sales price) is 1.60% annualized for an additional 19.2%.

The total potential 1-month return is 3.60% annualized to 43.2%.

However, be prepared with an exit strategy should the ETF move too far in either direction.

To learn more about mastering the skill of selling options and becoming an elite covered call writer and put-seller, visit The Blue Collar Investor.

StrategyAlthough the S&P 500 Index traditionally closes higher at the end of the fourth quarter especially during a Presidential election year a declining, euro could make it harder for OPEC crude oil producers, along with Russia to support prices until the November 30 OPEC meeting. As a reminder, according to Citi Bank research, currently about 75% of US equity market variance is explained by marco variables, such as exchange rates and bond prices.




With the threat of a US dollar interest rate hike back on the table once again and the euro declining, equity markets seem more focused on earnings reports and less on the potential to pressure crude oil prices lower before the November 30 OPEC meeting. As the Presidential election approaches, traditional market risk indicators seemingly reflect little concern.


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


ActionActionable Options™

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.

"Options data with predictive qualities - Nobody does it better!"

Next week expect more trade ideas from our rankers and scanners as ongoing 3Q earnings reports will likely create more opportunities.


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 source is the Table of Contents link found in the lower right side of the IVolatility Trading Digest section on the home page of our website.

CommentAs 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 at Support@IVolatility.com or use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com website. To receive the Digest by e-mail let us know at Support@IVolatility.com



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