« October 2017 »

IVolatility Trading Digest™

Volume 17 Issue 40
Bullish Foremost Indicators [Charts]

Bullish Foremost Indicators [Charts] - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Here at the start of the fourth quarter seems like a good time to check our Foremost Indicators for any warning signs as the S&P 500 Index makes new highs almost every day. Although limited space precludes a comprehensive review a few noteworthy ones follow along with a suggestion for Power Shares DB US Dollar Index Bullish Fund (UUP) then a VIX Carry Trade update for ProShares Short VIX Short-Term Futures (SVXY) and a Commitment of Traders update for WTI crude oil. First our regular S&P 500 Index and VIX updates.

Review NotesS&P 500 Index (SPX) 2549.33 added another 29.97 points or +1.09% for the week making new closing highs every day except Friday following the employment report. From both overbought and cyclical perspectives it's difficult to see how it can continue advancing much more without pulling back, but the same could have been said two weeks ago as well. As a short-term warning sign watch for a key reversal, when it trades higher intraday but then closes lower on increased volume. If Friday's decline started a pullback watch for support at 2508 and then the 50-day moving average at 2480.

VIXCBOE Volatility Index® (VIX) 9.59 advanced .14 points or +1.47% for the week while our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option at 6.47 declined .26 points or -3.86%.

VIX Futures Premium

The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second month futures contracts.

With 7 trading days until October expiration, the day-weighted premium between October and November allocated 35 % to October and 65% to November for a 23.68% premium, near the upper boundary of the green zone between 10% and 30%.


The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration.

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Foremost Indicators

Among the closely watched Foremost Indicators the DJ Transportation Average ETF (IYT), Market Breadth and the US Dollar Index (DX) merit special attention.


At 177.77 -.39 participating in the advance with the DJ Industrial Index and the S&P 500 Index confirms the new highs from the Dow Theory perspective.

As for Market Breadth:


911.54 +3.42 and +117.05 for the week, if there was only indictor it would be a contender. Any divergence here is worth watching as it usually turns lower before pullbacks begin.

US Dollar Index (DX) 93.64 shown in the chart below as $USD looks like it is attempting to make a bottom and turn higher as indicated by the new upward sloping trendline, USTL and the slope of the 50-day moving average that has stopped declining. Now right below 94 any further advance above the blue dotted line would confirm the turn higher and provide a headwind for the large capitalization multinationals in the fourth quarter that have enjoyed currency translation tailwinds for the last two quarters.

Above charts Courtesy of StockCharts.com

93.64-.16 and +.76 for the week.

Fortunately any further advance can be hedged with options. Here is a conditional idea to consider in the event $USD or DX continues above 94.

Power Shares DB US Dollar Index Bullish Fund (UUP) 24.37 up .19 or +.79% for the week.

It's been a long time since UUP was an upside candidate, first the options data.

With a current Historical Volatility of 6.90 and 4.66 using the Parkinson's range method, the Implied Volatility Index Mean is 6.55 at .21 of the 52 week range. The implied volatility/historical volatility ratio using the range method is 1.41 so option prices are moderately high relative to the recent movement of the ETF. Friday’s option volume was 7,787 contracts with the 30-day average of 19,646 contracts with reasonable bid/ask spreads.

With a low range historical volatility consider using options with ample time to expiration. Here is one idea.


Use a close back below the 50-day moving average at 24.10 as the SU (stop/unwind). VIX Carry Trade Update

Digest Issue 35 "VIX Carry Trade & Crude Oil [Charts]" included two long suggestions for ProShares Short VIX Short-Term Futures (SVXY) 98.80. "Of the two inverse ETFs that short VIX futures and advance as the VIX declines SVXY has listed options with enough volume and open interest to consider."

Review Notes

First though, drum roll, please….

At the open:


Now marked-to-market and closed as options expiration approaches.


Booking the close at the bid the gain was 8.50 (12.50-4.00)

Here is result for the synthetic long idea.

At the open:


Debit 1.30 (6.50 -5.20)

Booking the close:


At the ask for the put buy of .64 and the bid for the call sale at 17.05 the proceeds are 16.41 less the opening debit of 1.30 for a gain of 15.11 in 32 days. No wonder shorting VIX futures has become such an attractive trade.

These extraordinary gains were due to the S&P 500 Index resuming its uptrend after correcting, the VIX declining and the VIX futures loosing time value. While the synthetic long with the short put had significant risk in the event of a further market decline, the risk for the long 87 call was limited and defined by the initial 4.00 debit.

Crude Oil Update

Crude OilWTI Light Sweet Crude Oil (CL) 49.29 basis November futures declined 1.50 points or -2.38% for the week closing just below the 50-day moving average but still above the new operative upward sloping trendline, USTL.


From the Disaggregated Commitments of Traders - Options and Futures Combined report as of October 3 "Managed Money,” the group that best correlates with crude oil price changes and arguably the most important, increased their long position adding 1,913 contracts while increasing their shorts -4,378 for a net position decrease of -1,831 contracts representing 7.79% of the open interest down from 7.95% last week.


7.79 % or 249,323 contracts vs. 7.95% or 251,154 contracts week ending September 26.

All shown by change in numbers of contracts.
Producer/Merchant/Processor/User, (Commercials ) or "PMP" +5,312
Swap Dealers, or "Swaps" -13,200
Money Manager, or "Managed Money" -1,831
Other Reportables, or "Others" +1,272
Nonreportable Positions (Small Speculators ) +9,081

Typically Producer/Merchant/Processor/User, (Commercials ) or "PMP" are net short contracts as producers hedge production by selling futures contracts and then delivering crude against their shorts at expiration or if the price declined, buying back short contracts for a gain and buying cash crude for delivery. However, since processors and users are also included in this category their buying partially offsets producer selling resulting in a net short position.

Shown as a percentage of open interest the chart below shows a declining net short position since peaking at 12.03% on April 19, 2016 when cash crude was 40.91.


2.59% or -82,764 contracts vs. 2.79% or -88,076 contracts week ending September 26 and the lowest since December 9, 2014 at 2.73% when they were net short 62,444 contracts while cash WTI was 63.75 and declining.

Either producers are unwilling to sell production forward at current prices or they have already hedged all available production while demand from processors and users continues to rise as they hedge against future price increases. Alternatively, increasing Swaps short interest while PMP short interest declines suggests producers are using more swaps for hedging.


13.35% or -426,891 contracts vs.13.10% or -413,691 contracts week ending September 26.

The U.S. Energy Administration, EIA claims Swaps represent producer hedging along with PMP. When combined there net short position as a % of the open interest looks fairly stable as shown below.


15.93% or -509,655 contracts vs. 15.89% or 501,767 contracts week ending September 26. The net short position from this perspective has a slight uptrend since February 2, 2016.

Adding Brent to the equation supports the increasing demand or perhaps declining global inventory scenario as the Brent premium over WTI began increasing on August 18 from the 2-3 range to 6.33 above WTI on October 6.

On September 12 Reuters reported the volume of crude oil stored offshore in the North Sea declined in the last month, consistent with Brent futures moving into backwardation when the front month contracts trade at a premium to the deferred contracts making storage trades uneconomical a condition associated with a tightening market.

Currently in backwardation December 2017 Brent futures at 55.62 are 1.47 or 2.64% higher than December 2018 at 54.15.

WTI futures remain in slight contango of .58 or 1.17% with December 2017 futures at 49.65 compared to December 2018 at 50.23.

Since October is typically one of the seasonally weaker months the current Brent premium over WTI suggests prices remain firm perhaps due to stockpile hedging geopolitical risk.

The short version of a long story says both Brent and WTI crude are unusually strong for this time of the year reflecting increased demand and reduced OPEC supplies.

StrategyAlthoug options are not expensive as measured by implied volatility that by itself is not a sufficient reason to consider hedging . Unlike traditional insurance using options offers the ability to wait until the indicators begin signaling caution, except for a key reversal, before considering the cost of hedging. Except for hedging an unforseen geopolitical event, options allows waiting unitl it starts raining to buy flood insurance since there is no reason to pay the premium while the sun is shining.


After making four new closing highs last week, Friday's modest decline after the employment report may not be a good reason to become more cautions, but the rapid advance now makes the S&P 500 Index along with the other major indexes overbought and when combined with an overdue cyclical decline increases awareness of a potential pullback to recent support at 2508 and then the 50-day moving average at 2480.

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Finding Previous Issues and Our Reader Response Request

PreviousIssuesAll 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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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".