Volatility Trading Digest - Nemesis of the Longs
Volatility Trading Digest - Nemesis of the Longs
As if to say there is a limited permissible travel speed, corrections are the "Nemesis of the Longs". Nemesis, related to the Greek word némein, meaning "to give what is due", as depicted on the Greek coin, was the goddess of divine indignation and retribution, who punished excessive pride, arrogance, or good fortune, and the absence of moderation.
S&P 500 Index (SPX)
The third quarter ended in a quiet correction, as we suggested it might last week. Now that September options and futures are gone and 3Q earnings reports will soon be arriving after the September employment report, we wonder if they will be enough to take our attention away from the daily gyrations of euro that seems to be driving the equity markets lately.
E-mini S&P 500 Future (ESZ2)
During the first week after the September expiration, open interest resumed advancing moderately after the large decline due to the expiration. As a reminder we follow changes in the volume and open interest since a healthy trend needs open interest to continue expanding and any decline in open interest, especially on large volume in excess of about 3 million contracts could indicate a change in the major trend as existing longs liquidate to existing shorts who begin covering.
S&P Index Implied Volatility (IVXM)
At the end of last week, the Implied Volatility Index Mean increased from 11.31 to 12.89, while the CBOE Volatility Index (VIX) increased from 13.98 15.73.
The table below shows the VIX cash compared to the next two futures contracts as well as our calculation of Larry McMillan's day-weighted average between the first and second months.
The day weighting applied 60% to October and 40% to November resulting in the average premium of 1.31or 8.35% shown above. Our alternative volume weighting between October and November calculates to be a very similar 8.63% premium. Last week the day-weighted premium was 16.75%, while the volume weighted was 19.89%. The decline suggests there was a lot less interest in hedging at the current level. Friday's volume was 103,032 contracts and the open interest was 384,291 contracts.
VIX Options
With a current 30-day Historical Volatility of 100.31 and 78.33 using Parkinson's range method, the table below shows the Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon Friday's closing option mid prices along with their respective month's futures prices, since the options are priced from the tradeable futures.
Using the IV Index Mean of 76.12 the IV/HV ratio is .76, using the range method for Historical Volatility the ratio is .97 while the VIX put-call ratio at .27, down from .42 last week, is now quite bullish for VIX, but bearish for the SPX since they move in opposite directions. Friday's options volume was 529,386 contacts compared to the 5-day average of 461,080 contracts. The lower premium in the futures seems offset by more volume in the options.
CBOE S&P 500 Skew Index (SKEW)
Designed to measure the purchase of out-of-the-money S&P 500 Index puts that would require a very large downside move to profit from long put positions, an increase of this index indicates a higher expectation of an extreme down move. After a quick spike up to 130.67 on Friday September 21, most likely related to options and futures expiration, it declined back into the upper part of the new 114-130 range. Remaining in the upper part of this range indicates OTM puts are still very much in demand.
CurrencyShares Euro Trust (FXE)
Recently it seems all "risk on" assets, including equities, have been following the euro. When the euro is up "risk on" assets are also up and vice versa. Lately it seems all the focus of attention has been on Europe in general and Spain in particular, as nothing else seems to matter, not the US economy, the "fiscal cliff", the upcoming elections, or even disappointing earnings pre-announcements. All one needs to do was watch the euro for a sense of market direction. Of course, it is not that simple as the charts below from the Correlation function in our Advanced Historical Data section illustrates the 30-day correlation between the S&P 500 Index and FXE, which is now only 40.25, having been as high as 72 in late July.
NYSE McClellan Summation Index
Not surprisingly, our NYSE Composite breadth indicator declined 70.68 points since we last reported two weeks ago, with 138.66 points of the decline occurring last week, as the correction got underway. For now, the issue of divergence is not a major concern, as breadth and the composite index are moving together.
iShares Dow Jones Transportation Average Index (IYT)
If one were looking for the "Dogs of the Dow", a good place to begin would be in the transportation index since it is back near the bottom of the range it made last June. It is difficult to see how the major market indexes can continue very much higher if this group continues to wane. In order to improve, they would need to get some help from declining crude oil prices, to provide some cost pressure relief, since transportation demand has slowed in certain sectors.
SPDR Homebuilders (XHB)
As we noted two weeks ago, this top ranked group was almost four points above our upward sloping trendline, overbought and vulnerable to a near term correction. As cautioned, a correction began last week and now the question is how much further it goes? Since the Federal Reserve is targeting housing construction employment with its open-ended mortgage buying plan, and with home prices now increasing once again, we think the answer is not very much lower.
United States Oil (USO)
Absent any unforeseen surprises from the Middle East, we think chances are good that crude oil prices will continue the expected seasonal decline that began on September 18 when it closed below our upward sloping trendline. This should give some needed help for both the transports and the consumer discretionary sectors since less money will be needed for transportation fuels. In the absence of the often-cited Middle East risk premium, USO seems likely to decline to the 30 level or about 80 per barrel for WTI crude.
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