« September 2018 »

IVolatility Trading Digest™

Volume 18 Issue 37
Rotation Rethink [Charts]

TOP 5 [Charts] - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Last week Digest Issue 36 "Pullback Update [Charts]" suggested the time had come to start looking for the S&P 500 Index to make an upside reversal; it came the next day. Now approaching the previous August 29 high at 2916.50, can it quickly overcome resistance and continue higher? The market review includes a few charts addressing the question along with some thoughts about the current state of sector rotation. Then consider iShares 20+ Treasury Bond ETF (TLT) and iShares China Large-Cap ETF (FXI) as contrarian ideas.

Review NotesS&P 500 Index (SPX) 2904.98 marched higher adding 33.30 points or +1.16% for the week, after making a reversal last Monday. The upside objective is to close back above the August 29 high at 2916.50. There is support around 2850, then at the 50-day Moving Average now 2844.36, and more between 2800 and 2790. Then operative upward sloping trendline (USTL) from the April low crosses around 2770.

VIXCBOE Volatility Index® (VIX) 12.07 dropped 2.81 points or -18.88% last week. 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, declined slightly more -2.27 points or -22.04%, shown in this six month chart that includes the April volatility high followed by the SPX line chart.


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 just 2 trading days until September expiration, the day-weighted premium between September and October allocated 10% to September and 90% to October for a 17.95% premium , well back into the bullish green zone between 10% and 20%.


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. Previously declines below 10% and advances above 30% were unstable.

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Foremost Indicators

CBOE S&P 500 Skew Index (SKEW) 151.59 advanced 5.72 points or +3.92% for the 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 indicates greater expectations for an extreme down move. The CBOE explains: 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.

In the past brief spikes above 140 were usually associated with specific events, but now with several closes above 150, the events indicator level needs revising. In addition, it appears to be trending higher as defined by the upward sloping trendline (USTL) also called the "Hedge Line." Could it be related to trade negotiations and tariffs? Probably.


Market BreadthMarket Breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that considers the number of issues traded, and reported by McClellan Financial Publications, declined 100.89 points or -19.20% last week. While not necessarily a leading indicator, advances and declines above and below the 50-day moving average have been good for confirming the market direction. However, the current divergence causes concern. After the NYSE Composite Index and S&P 500 Index made new highs on August 29 the breadth was less than it was when the indexes made previous highs and June. This chart helps tell the story.


The blue arrow marks the August 29 top for both the S&P 500 Index and the Summation Index while red circle highlights crossing below the 50-day moving average. Based on this indicator, unless breadth begins to improve the S&P 500 Index will likely encounter difficulty at the previous high.

Sector Rotation

What happens when "Risk On" and "Risk Off" sectors start moving together? When the oversold sectors are no longer oversold? Does it mean the whole market declines or just stalls until there are oversold sectors once again? Perhaps our old friends the "Algo Rotators," our adaption to "Whac-a mole" called" Whac-a Sector,” with high frequency traders doing the whacking, first introduced in Digest Volume 16, Issue 23 "Rotation Redux," will move on looking for other oversold opportunities, such as long Treasury Bonds represented by iShares 20+ Treasury Bond ETF (TLT) or even China using iShares China Large-Cap ETF (FXI).


The VIX 10-day Correlation indicator featured last week in Digest Issue 36 "Pullback Update "quickly returned back to -.90 last Tuesday, confirming the reversal and advance by the S&P 500 Index.

Rather than trying to find a sector or index near it's high expecting it will break out and continue higher , here are contrarian rotation prospects to consider near their lows.

iShares 20+ Treasury Bond ETF (TLT) 118.55 down .58 points or -.49% for the week and now near the bottom of the 118-122 range. With good volume and liquidity take a look at the October 19 119/122 call spread. (Long the October 19 119 call and short the October 122 call) for a debit of .78 about 26% of the spread width. Set the SU (stop/unwind) at a close 117.50.

iShares China Large-Cap ETF (FXI) 41.23 up .32 or +.78 for the week. After making a second test of the August 15 reversal low at 40.04 then going down to 39.82 on September 11, it quickly rebounded once again on very high ETF and options volume . While acknowledging it may not have reached the bottom, here is another call spread idea with defined and limited risk. Long October 42/44 call spread. (Long the October 42 call and short the October 44 call) for a debit of .55 about 28% of the spread width. Use a close back below the September 11 low of 39.82 as the SU (stop/unwind).


Last week the anticipated reversal by the S&P 500 Index occurred as expected, although without the usual reversal high volume. It now appears headed back up to test the previous high, where it will likely encounter formidable resistance unless market breadth begins to improve. In the meanwhile, since many equity sectors appear overbought it may be a good time to consider long Treasury Bonds along with another attempt at finding the bottom in the Chinese markets.

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

Next week the plan is to fire up the rankers and scanners looking for more trade ideas along with our regular market review.

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 always, 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 Trading DigestTM Disclaimer
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".