Volatility Trading Digest: Greek Strategy

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Volatility Trading Digest:  Greek Strategy

Our rotation index closed the week at 1.219 compared to last week at 1.243.  As the index declines, it reflects relative strength of the consumer staple stocks compared to the consumer discretionary stocks.

Based upon our VIX Futures premium indictor above we expect to see another near term rally in the major equity indexes before turning lower once again.  This should give us another opportunity to establish or add downside hedges.  Once again, we suggest IWM.

iShares Russell 2000 Index (IWM)
The current Historical Volatility is 21.10 while the Implied Volatility Index Mean is 25.19, for an IV/HV ratio of 1.19.  The put-call ratio is in negative territory at 2.45, but since it is used extensively for hedging, the put-call ratio is usually in the 2 to 4 range.
 

 
Fridays option volume was 679,694 contracts compared to the 5-day average volume of 682,590 contracts.  Use a close back above 80 as the SU (stop/unwind). 

Once the expected short-term oversold bounce is complete, we think the chances are good equities will turn lower once again.  Here are some of the reasons.

• The market breadth continues to deteriorate.
• The 8.2% decline has not yet reached the 10% level normally associated with corrections.
• Summer is a seasonally weak period for equities.
• Greece is still in the news and the default issue has not been completely resolved.

If so, we need to identify a possible support level to watch as the S&P 500 Index declines.  Consider the long-term uptrend line shown below.


 
Based upon the trendline approach we can expect to see some support at the 1225 level.  However, we note since this is a long-term chart technically we should be using a logarithmic scale chart and based upon that the index is already below the upward sloping trendline, but there appears to be good support at 1200 so this also makes a likely downside objective.
    
Currency Hedge

Since the Greek debt issue has yet to be resolved, perhaps it is time to consider a currency hedge strategy.  Here is one idea.

ProShares UltraShort Euro (EUO)
The ETF seeks to provide daily move corresponding to twice (200%) the inverse (opposite) of the daily change in the US dollar price of the euro.  The fund invests in swap agreement, futures contracts, forward contracts, option contracts.

The current Historical Volatility is 25.80, with an Implied Volatility Index Mean of 32.35, up from 27.68 last week, for an IV/HV ratio of 1.25, and a very bullish .3 put-call ratio (bearish for the euro).

Friday's option volume at 6,663 contracts compared to the 5-day average of 5,380 makes the options fairly thin especially in the deferred month contracts, so there may be some advantage in legging into the position.



With a good volatility edge, the debit is a favorable 20% of the distance between the strike prices providing an attractive 4:1 risk to reward ratio.  Use a close back below the last pivot just under 16.50 as the SU (stop/unwind).

Lost Momentum

Apple Inc. (AAPL)
The two previous suggestions were conditional upon AAPL closing below 325 and this occurred on Friday as it declined 4.90 points.  Although the implied volatility is now higher making the spread more expensive, it is still better to have waited for it to close below the neckline of the previously described Head & Shoulders pattern before initiating the trade.  Here is an updated spread extending the time out to August and beyond the next scheduled earnings report on July 19.

The current Historical Volatility is 19.04, with an Implied Volatility Index Mean of 28.67, up from 22.67 last week, for an IV/HV ratio of 1.51.  The put-call ratio at .86 is bearish.  Friday's option volume was 533,888 contracts compared to the 5-day average of 359,450 contracts, a substantial increase and the put-call ratio indicates there were more puts than calls.



Use a close back above the multiple resistance points at 330 as the SU (stop/unwind).
All of the suggestions above are based upon last Friday's closing prices using the mid price between the bid and ask.  On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.

Summary
While the markets appear to be obsessed with risk-off positioning due to the continuing Greek saga, equities appear due for another oversold bounce before continuing lower while seeking support.
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