Volatility Trading Digest - VIX Futures Calling
Volatility Trading Digest - VIX Futures Calling
In our last Digest, once again we suggested using more hedging strategies based upon our indicators with special emphasis placed upon the increased VIX futures premium along with the expanding numbers of open contracts. We return to update the VIV futures data in the strategy section below followed by an update for our latest hedge suggestion and then three interesting new earnings report ideas along with Friday's number one IV/HV ratio pick.
Strategy
Referring to the market review from last week, we note the SPDR Homebuilders (XHB) continued trending higher while the iShares Dow Jones Transportation Average Index (IYT) made an impressive advance Thursday followed by another on Friday as it rose back up to challenge the February 3 high at 96.13, where it then meet resistance, closing off.10. In addition, the euro advanced slightly adding further support for equities.
However, our other important indicators continue to make the correction case.
Market breadth did not improve as the NYSE McClellan Summation Index declined 20.46, despite the continued advance in the major indexes, increasing this important negative divergence.
Second, our VIX futures premium closed at an all time high reflecting the extent of increased hedging activity. Here is the data.
S&P 500 Index Implied Volatility (IVXM)
Last week Implied Volatility Index Mean declined from 14.16 to 12.54, while the CBOE Volatility Index (VIX) declined from 17.11 to 14.47.
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 8% to the March contract that will expire Wednesday morning and 92% to April resulting in the average premium of 6.69 or 46.26 shown above. Our alternative volume weighting between March and April results in a 33.22% premium.
For this short-term indicator the premium to the cash is a SPX sell signal suggesting professional expectations for the cash to increase toward the futures price. These are the highest premium levels recorded since we have been collecting this data. In the past, premium levels in excess of 20% usually preceded corrections. The continued expansion of open interest last week closing up 20% at 332,948 contracts as of Thursday, confirms the additional hedging activity.
For this short-term indicator the premium to the cash is a SPX sell signal suggesting professional expectations for the cash to increase toward the futures price. These are the highest premium levels recorded since we have been collecting this data. In the past, premium levels in excess of 20% usually preceded corrections. The continued expansion of open interest last week closing up 20% at 332,948 contracts as of Thursday, confirms the additional hedging activity.
Another gauge we follow is the CBOE S&P 500 Skew Index (SKEW) that indicates purchase activity of out-of-the money S&P 500 Index puts used for downside protection. While swinging wildly during the week it closed three days above the previous all time high range of 130, indicting active index put buying confirmed by the high SPX put-call ratio at 2.10.
Based upon the above we continue to suggest hedging long portfolio risk.
Update
Last week we suggested a SPDR S&P 500 Index (SPY) put ratio backspread. Our trade plan was to close the position in the event SPY closed above 140, which occurred on Thursday as SPY closed at 140.72. Accordingly, we booked the close on Friday for a net .22 credit after losing .39 from the original credit of .61 that we recorded the previous Monday. Although our initial forecast was wrong, we were able to salvage the position since we moved quickly to close it eliminating our time decay risk from the extra long put. While our indictors above continue to suggest a market correction, we will wait to see a close below the current upward sloping trendline at 137.50 before renewing this one.
Summary
Based upon our market indicators the weight of evidence leads to the conclusion professional traders and strategists are expecting a correction. Accordingly, we suggest being ready with more hedging strategies to be implemented as soon as the major indexes begin showing signs of rolling over.
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