« October 2018 »

IVolatility Trading Digest™

Volume 18 Issue 43
Bear Flag [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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Once again the plan to search for more new trade ideas has been overwhelmed by the continuing decline of the S&P 500 Index. From a classical bar chart perspective, it now looks as if a Bear Flag has become the operative pattern with a defined downside objective. While market breadth continues deteriorating, indicators from the futures and options markets are not reflecting extreme negative sentiment usually associated with market bottoms.

Review NotesS&P 500 Index (SPX) 2658.69 lost 109.09 or -3.94% last week. Now considerably below the 200-day Moving Average at 2767.03, that provided no support whatsoever as SPX dropped like a stone thrown over a cliff. The comparison made last week in Digest Issue 42 "Rising Wedge 2.0 [Charts]" to a potential Rising Wedge evaporated last Tuesday when it failed to turn higher setting off a Bear Flag detailed below.

VIXCBOE Volatility Index® (VIX) 24.16 jumped up 4.27 points or +21.47% 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, added 4.30 points or +26.38% to 20.60.

During the market decline last February the VIX reached an intraday high of 50.30 on February 6, closing at 29.98. On this decline so far, the intraday high was 28.84 on October 11, closing at 24.98. One interpretation is less hedging activity and therefore more relative strength than in February. However, that view comes up short when considering market breadth as shown in the chart below. The alternative interpretation suggests the high for this decline remains to be determined.

Look at the IVolatility Implied Volatility Index Mean, IVXM chart showing a spike up above 30% in February compared to the more recent spike above 20%, now 20.60.


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. Note: last week the editor failed to add the chart, but it's here now.

With 17 trading days until November expiration, the day-weighted premium between November and December allocated 68% to November and 32% to December for a -13.22% premium vs. -6.91% last week ending October 19, well below the bottom of the green zone between 10% to 20%. Let's call it in the Risk Off zone.

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.


For daily updates, follow our end-of- day volume weighted premium version located about half-way down the home page in the Options Data Analysis section on our website.

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Bear Flag

Review NotesFlags mark a half-way counter trend resting place consisting of several narrow range up days before the trend resumes. The measuring objective is determined by taking the distance from the downside breakout to the bottom of the flag pole, subtracted from the top of the flag.

In a downtrend , the flag is composed of several narrow range up days against the downtrend underway. Take a look at the SPX Bear Flag.


The downside breakout happened October 10 when it closed substantially below the low of October 8 at 2862.08 marked above. The bottom of flag pole was reached at the October 11 low of 2710.51 creating a height of 151.57 (2862.08-2710.51).
Subtracting the height from the top of flag, shown above at 2816.94, produces the minimum measuring objective, MO at 2665.37 (2816.94 -151.57) marked in green above by the small arrow, very close to Friday's opening. However, reaching the minimum objective does not mean it's the final low.

Extremely Negative Market Breadth

Review NotesMarket 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 another 215.33 points or -43.11% last week ending at -714.68. 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 as reported in Digest Issue 37 "Rotation Rethink [Charts]" when it last declined below the 50-day MA.

Updating last week's chart in Digest Issue 42 "Rising Wedge 2.0 [Charts]" showing the index compared to the decline that began on January 26, this one goes back to the low made November 10, 2016 at -303.56.


In the same time frame, the SPX shown below bottomed November 4, 2016 at 2083.79 and market breadth turned higher November 10, 2016 two days after the presidential election. This weekly SPX chart shows last week's close below the upward sloping trendline, USTL from the November 4, 2016 low.



Where is the bottom?

As mentioned above reaching the minimum measuring objective defined by a Bear Flag doesn't mean the low has been reached. However, it does suggest being alert for a capitulation bottom when the VIX and IVXM spike higher along with a more negative VIX futures premium now -13.22 and increasing VIX futures options volume and open interest. For example, during the January -February market decline the futures premium reached -27.41% on February 9 with options open interest of 14.4 million contracts vs.7.0 million last Friday.

Markets don't like uncertainty, as we know, and since November 6 mid-term elections in the US are quickly approaching; considering the breakdown of the uptrend from the November 4, 2016 low implies election uncertainty, along with rising interest rates and China tariffs, all contributing to the current market decline. If so, it's reasonable to assume the low could come just before or shortly after November 6. Look for a key reversal, defined as lower low and a higher close with an expanded range on increased volume as the bulls and bears fight to the finish.

When the bottom is reached confirmed by improving market breadth, consider positions in the market leaders that have gone down the least since this is where the smart money has gone, along with the ones that have gone down the most since they will bounce back fastest.

There may be something more important than market timing but whatever it is there is nothing more consistently important than getting the timing right.

Although not confirmed this quote was been attributed to John Magee, co-author with Robert D. Edwards of Technical Analysis of Stock Trends. "Don't tell me what to buy-tell me when to buy it."


The market decline that began after making a small double top on October 3 and quickly gained downside momentum developed into a Bear Flag pattern that reached its minimum downside measuring objective Friday. However, election uncertainty, rising interest rates and China tariff issues suggest the S&P 500 Index bottom has not likely been reached. However, since Mondays in October have a bad reputation it could come real soon.

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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, like the last three, the plan includes more trading ideas from our rankers and scanners.

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".