« November 2018 »

IVolatility Trading Digest™

Volume 18 Issue 44
The Gap [Charts]

TOP 5 [Charts] - IVolatility Trading Digest™

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

Last week it was about a Bear Flag, this week it's about the S&P 500 Index gapping up at the opening Wednesday. While easy to conclude the gap confirms a short-term trend change after reaching a bottom last Monday, it may not be quite that simple. Although market breadth turned higher the futures and options markets are still not reflecting extreme negative sentiment usually associated with market bottoms. However, a tradable bounce seems worth considering, so a long call idea for SPDR S&P 500 ETF (SPY) follows the regular market review.

Review NotesS&P 500 Index (SPX) 2723.06 made quite a recovery last week adding 64.37 points or +2.42%, but still below the 200-day Moving Average at 2764.66. The main attraction on the center stage is the gap up opening on Wednesday October 31, explored in some detail below.

VIXCBOE Volatility Index® (VIX) 19.51 backed off 4.65 points or -19.25% 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 3.77 points or -18.30% to 16.83. This six month chart shows IVXM declining as SPX turned higher.


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 12 trading days until November expiration, the day-weighted premium between November and December allocated 48% to November and 52% to December for a -.79% premium vs. -13.22% last week ending October 26, still below the bottom of the green zone between 10% to 20%. While better, it's still not positive with all futures contracts except November under the VIX.

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.


Still in the Risk Off zone, so no green light for the bulls here.

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.

Big Data? In options we are Big Data!

Try our slick new Probability Calculator

The Gap

After the S&P 500 Index opened with a gap up last Wednesday, on news that China’s leadership signaled further stimulus measures are being planned, the challenge is to classify it since there is more than one type of gap each with different implications for tactical trading strategies. Pattern, also called common gaps, occur within a congestion or classical pattern such as a symmetrical triangle, and are quickly closed. Measuring gaps that appear during a rapid straight line price move are never closed. Exhaustion gaps develop at the end of a price move and are quickly closed.

Breakaway gaps like the one under consideration that happened last Wednesday complete a price pattern. The first criterion is to identify the completed pattern. Last week Digest Issue 43 "Bear Flag [Charts]" suggested the SPX decline would continue until it reached a minimum downside objective at 2665. Last Monday it declined as low as 2603.54 closing at 2641.25 on increased volume of 2.8 billion shares, the combined volume of all the component stocks, completing the Bear Flag pattern. The next day it rebounded closing up 41.38 points or +1.57% on 3.3 billion combined share volume. Then Wednesday it opened gap up closing higher by 29.11 points or +1.09% on still high combined volume of 3.1 billion shares. Why all the volume detail?

"Breakaway gaps usually occur in heavy volume. More often than not, breakaway gaps are not filled. Prices may return to the upper end of the gap (in the case of a bullish breakout), and may even close a portion of the gap, but some portion of the gap is usually left unfilled. As rule , the heavier the volume after such a gap appears, the less likely it is to be filled. In fact, if the gap is completely filled, with prices moving back below the gap area, that may be an indication of a false breakout." John J. Murphy Technical Analysis of the Futures Markets, p 98.

Take a look at these two thumb nail charts courtesy of StockCharts.com.

                              First the SPX.                                          Next, the tradable SPDR S&P 500 ETF (SPY)


While SPX seems to fulfill the volume requirement tradable SPY came up short as the volume declined on the breakout.

However, since futures and options also trade based on the S&P 500 Index perhaps they will help resolve what appears as a volume discrepancy.

Two December futures charts below provided by Barchart.com don't seem to help very much. The first is the large futures contract, SPZ18 showing Wednesday's volume increased somewhat, but nowhere near high volume. In addition, it has no breakaway gap, just an advance on what looks like normal volume.

How about the e-mini S&P contract, ESZ18, the second chart. Again volume appears less than convincing without a breakaway gap.

                                      SPZ18                                                                            ESZ18


Although other tradable derivatives based upon the S&P 500 Index complicate the analysis, less than high volume and lack of gaps in the futures contracts makes it difficult to conclude last Wednesday's SPX gap was a breakaway, suggesting the gap may be filled as it attempts to retest last Monday's low.

Now add market breadth to the analysis.

Market Breadth Improves

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, advanced 8.74 points or +1.22% for the week ending at -706.06 after declining every week since August 31. This turn should get the attention of both the bulls and bears since it has been a good indictor at important market turns. While still a long way below the 50-day moving average, now 42.20, the long awaited turn increases the probability that the October sell-off has run its course.

Here is one more thumb nail chart courtesy of StockCharts.com.


Tradable Bounce

SPDR S&P 500 ETF (SPY) 271.89 declined 1.62 points or -.59% Friday making an outside range day buffeted by China trade comments, first by Trump, then Kudlow, then Trump again.

With a current Historical Volatility of 19.84 and 17.43 using the Parkinson's range method, the Implied Volatility Index Mean is 16.87 at .39 of the 52-week range. The implied volatility/historical volatility ratio using the range method is .97 so option prices are reasonable relative to the recent movement of the ETF by this measure.

As the option volume leader Friday 3,844,866 contracts traded with the 5-day average of 3,814,430 contracts with a normal put/call ratio of 1.25 and reasonable bid/ask spreads with open interest of 25,554,700. Plenty of volume and liquidity here.


Using the ask price for the buy and mid for the sell the long call spread debit would be 2.36 about 47% of the distance between the strike prices with 59% of the long call risk hedged by the short call. Until the gap question is resolved the objective is the have hedged, limited and defined risk while participating in the expected bounce. Use a close below the gap about 265 as the SU (stop/unwind).

The spread suggestion above is based on the ask price for the buy and middle price for the sell presuming some price improvement is possible. Monday’s option prices will be somewhat different due to the time decay over the weekend and any price change.


While it appears as if the S&P 500 Index bottom was reached Monday October 29, the gap question suggests caution at least until after the mid-term election results Wednesday.

Then, since bottom may have been 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 such as those in the Communication Services sector.


The market decline that began after the S&P 500 Index made a small double top on October 3, may have reached a bottom last week after completing a Bear Flag minimum downside measuring objective confirmed by a subsequent possible upside breakaway gap up opening along with improving market breadth. It's heading for the clearing, but not yet out of the woods.

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

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, more market review along with an update on the gap question and a look at WTI crude oil.

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




Comments are closed for this entry.

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".