« March 2018 »

IVolatility Trading Digest™

Volume 18 Issue 12
Rising Wedge [Charts]

Rising Wedge [Charts] - IVolatility Trading Digest™

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After five weeks speculating about the shape of classical barchart pattern underway, the answer came last Monday as the S&P 500 Index gapped lower on the open, setting off a Rising Wedge, first identified in Digest Issue 9 "Correction Resumes [Charts]." The review below adds more detail along with updating the VIX Futures Premium chart followed by a look at the most recent Commitment of Traders report for WTI crude oil.

Review NotesS&P 500 Index (SPX)2588.26 dropped a whopping 163.75 points or -5.95% last week activating the bearish rising wedge described in Digest Issue 9 "Correction Resumes [Charts]." after the relative strength in the tech sector that had been supporting the market faded away.

Last Monday's gap open decline to close below the lower upward sloping trendline confirmed the Rising Wedge interpretation with a minimum measuring objective at 2545 or 195 points lower from 2740. With just over 40 more points to reach the objective, marked with the small green arrow in the lower right corner in the chart above, start watching reversal signs on increasing volume.


VIXCBOE Volatility Index® (VIX) 24.87 spiked up 9.07 points or +57.41% last week. The advance in 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, was even more dramatic adding 8.62 points or 79.01% reaching 19.53 on the close Friday.


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 17 trading days until April expiration, the day-weighted premium between April and May allocated 85% to April and 15% to May for a -18.44 well into the red zone once again.


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. At the extremes, declines below 10 and advances above 30 are both unstable.

However, there was one hint Friday that the correction may be near the end. VIX options open interest at 7.3 million contracts was 52% of the previous week at 13.9 million but that was March expiration Friday. Compared to the average for the prior 4 Friday's including February's options expiration at 11.7 million, last Friday's open interest was just 62% of the average, a noticeable decline.

Foremost Indicator Update

CBOE S&P 500 Skew Index(SKEW) 130.79 declined 16.56 points or -11.24% last week. SKEW measures purchases 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. The CBOE explains further, a Skew value of 100 means the perceived distribution of S&P 500 Index log-returns is normal so the probability of outlier returns is negligible. Calculated from SPX option prices it describes "tail risk." As Skew rises above 100, the left tail of the distribution acquires more weight increasing the probability of outlier returns. This chart suggests the hedged anticipated event occurred.


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Crude Oil

Crude OilWTI Crude Oil (CL) 65.88 +1.58 or +2.24% basis May futures Friday. For the week +3.33 or +5.34%. Both WTI and Brent crude remain in backdawardation, when near term contract prices exceed deferreds, for WTI 5.79 or 8.79%, for Brent 5.16 or +7.32%, both May 18 to May 19, suggesting doubt about the usual seasonal price decline.

According the EIA crude inventory, now in the middle of its 5-year range, continues to decline despite increased US production, now greater than 10 million barrels a day. Comments from Saudi Energy Minister Khalid al-Falih Friday further boosted prices saying he believes its necessary for OPEC and NOPEC to maintian produciton cuts in 2019. Since Saudi Aramco is ready to go public his comments supporting crude oil prices are obviously intended to maximize the IPO price.

From the Disaggregated Commitments of Traders - Options and Futures Combined report as of March 20,"Managed Money," the group that best correlates with crude oil price changes and arguably the most important, increased their long position adding 23,736 contracts while decreasing their shorts +8,956 contracts for a net position increase of +32,691 contracts representing 14.51 % of the open interest up from 5.00% for the week ending August 29, 2017at the last pivot.


"Managed Money" now has 458,609 net long contracts vs.147,303 net long contracts or 5.00% of the open interest at the last pivot for the week ending August 29,2017. For another perspective this chart shows "Managed Money" short position is now 27,688 contracts, compared to 20,094 on June 10,2014 when cash WTI was 106.85.


A “money manager,” (Managed Money) 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 so tracking changes to their short position should be worthwhile. For now there is little enthusiasm for increasing their short position despite higher prices.


Last week's long suggestions in Digest Issue 11 "Correction Confusion [Charts]."for The Technology Select Sector SPDR® Fund(XLK) and FireEye Inc.(FEYE) fell victim to tariff chatter from Washington along with the ongoing correction. However, since the pattern has now been determined and the downside objective established, get prepared for the reversal. Since energy seems supported by OPEC commentary perhaps XLE call spreads with defined and limited risk are now timely.

Continue tracking the potential bottoming pattern underway in US Dollar Index (DX) & DXY, $USD, now 89.03 down .76 or -.85% last week. See the chart in Digest Issue 9 "Correction Resumes [Charts]." A double bottom or maybe a Head & Shoulders Bottom pattern appears underway.


Without technology's support the character of the correction was established as a bearish rising wedge with a defined minimum measuring objective that has nearly been reached. While a reversal could still be a few weeks away watch for an upside reversal on increasing volume and chatter about a double bottom formation.

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The markets will be closed Friday and Monday in Europe and because it has been awhile since we reviewed various volatility terms, next week will feature an updated version of "Volatility Lingo."

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.


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