Volatility Trading Digest - Strategy Selections
While third quarter earnings reports should be the focus of attention this week, we noted above the questionable condition of the S&P 500 Index (SPX). Here is the current chart along with more details.
The upward sloping trendline (USTL) above shows the status of the uptrend that began with the June 4 low at 1266.74. If it holds this line, the addition of the third trendline point will enhance its validity. However, there is a potential double top at the highs shown above as T1 and T2. A close below the August 21 high at 1426.66, slightly below the current close, will activate the pattern and will be below the USTL. In that event, the double top will be activated with minimum measuring objective at 1388 marked MO on the chart above.
Despite the precarious technical condition of the S&P 500 Index (SPX) the VIX, the VIX futures premium, nor the CBOE S&P 500 Skew Index (SKEW) seem to reflect as much concern as would be expected, which adds to the uncertainty. We also note some other important indexes like the iShares Russell 2000 Index (IWM) 82.10 and the PowerShares QQQ (QQQ) 66.68 are still above their respective upward sloping trendlines, but declining.
Until this week, we had been saying that underinvested mutual and hedge funds would be chasing performance since they risk losing assets under management if their year-end performance lags the S&P 500 Index and that it could reach 1500 by the end of the year. Now unless SPX holds the upward sloping trendline then we will conclude profit taking is more important than chasing year-end performance.
If the decline continues, then the VIX will increase along with the implied volatility of individual stocks so consider using long straddles and strangles for the Volatility Kings listed last week.
October Options Expiration
The regular October options will expire Saturday so the last trading day is Friday. As the market had been rising we have added more October positions than usual to the Digest portfolio so we will begin closing or unwinding them on Monday, especially if SPX looks like it will close below 1426.66.
For the true believers who have been right for so long we have a conditional suggestion to consider.
Apple Inc. (AAPL)
With their earnings report scheduled for release after the close on October 25, with a consensus estimate of 8.98 per share and a whisper number at 10.02, carefully watch the closing prices early this week.
For those thinking the current correction from the September 21 high at 705.07 down to the upward sloping trendline, where it now rests is a buying opportunity, consider that it has formed a complex Head & Shoulders Top with a downside-measuring objective at 600. However, with any improving market sentiment early in the week it will likely bounce quickly off the trendline support.
In that event, here is a call spread to consider.
First, the options data.
The current Historical Volatility is 22.39 and 18.35 using the Parkinson's range method, with an Implied Volatility Index Mean of 34.57 up from 34.30 last week. The IV/HV ratio is 1.54 and 1.88 using the range method to calculate the HV. Friday's put-call ratio was in bearish territory at 1.00, while the volume was 930,259 contracts traded compared to the 5-day average volume of 872,010.
One of the advantages of using call spreads is the opportunity to participate trading high priced stocks with a relatively low and defined risk. For this particular suggestion, there is no volatility edge and the risk reward ratio, with the cost 44% of the distance between the strikes is not very good, but it does offer a low cost low risk way to see if it will turn higher. On the other hand if it continues lower Monday and closes below the upward sloping trendline, now at 629 we suggest deferring the trade and wait until it reaches 600, the downside-measuring objective for the Head & Shoulders Top mentioned above.
The suggestion above uses the closing middle price between the Friday bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
The S&P 500 Index is at an important juncture going into 3Q earnings reporting. Any lower close means the correction could become something more than profit taking suggesting serious liquidation could be underway that may last into the election and perhaps beyond.
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