Volatility Trading Digest - Market Review

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Volatility Trading Digest - Market Review

S&P 500 Index (SPX)
Last week after the right shoulder had been defined by the rally, we made the case for the formation of a potential Head & Shoulder Bottom. A close above the neckline at 1,350 would be required to activate the pattern that would have an estimated potential upside minimum measuring objective at 1,545. While we admit this may be just an exercise in wishful thinking we see similar bottoming patterns forming in many of the leading stocks.

E-mini S&P 500 Futures (ESZ1)
Based upon the preliminary CME report Friday's volume was 3.6 million contracts, substantially above the average, but since the contract expires at the end of the week, the increase is most likely due to the normal contract expiration surge as positions are being rolled over from December to March.

S&P 500 Index Implied Volatility (IVXM)
Since our last market review the Implied Volatility Index Mean declined from 31.44 to 23.45, while the CBOE Volatility Index (VIX) declined from 34.47 to 26.38.

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 28% to the December contract and 72% to January resulting in the average premium of 2.51 or 9.52% shown above. An alternative volume weighting between December and January results in a 7.47% 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. Last week the premium was 4.99%, compared to premium of 1.11% in our last market review based upon November 25 closing prices. Although the higher premium could be related to the substantial 13.76% decline in the VIX on Friday, the premiums over cash have been rising for three weeks, indicating a higher level of professional portfolio hedging activity. However, this time last year the premium was 20.85%.

Since the CBOE updates the VIX futures term structure during the day an estimate of the current premium or discount is always available.

VIX Options
With a current 30- day Historical Volatility of 142.54 and 79.68 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 the closing option mid prices on Friday along with their respective month's futures prices, since the options are priced from the futures.
 

 
Using the IV Index Mean of 82.89, the IV/HV ratio is .58, using the range method for Historical Volatility the ratio is 1.14 while the VIX put-call ratio at 1.45 is normally bearish for the S&P 500 Index, but could indicated active put selling in anticipation of a lower VIX going into year-end. This would be consistent with the SPX skew between the calls and puts, with the call-implied volatility at 24.10 compared to the puts at 22.80.

All of the Implied Volatilities along with the Historical Volatilities and Greeks for the VIX options based upon the Futures prices can be found on our Advanced Options page by clicking on the "market close" link shown near the top of the page.

CurrencyShares Euro Trust (FXE)
Since the market is focused upon the euro, we will use FXE as our currency indicator. Liquidity fluctuating between the euro and the dollar is the primary force behind the rotation out of "risk-on" positions, such as equities and commodities into "risk-off" alternatives, such as Treasury notes and bonds. Although there have been many rotations in the last year, over the longer term the euro appears to be near the middle of its range between 1.20 and 1.50. See the chart in the strategy section below. Currently in a decline, it looks oversold so there could be a rally into the year-end and perhaps extending into the first few weeks of 2012.

NYSE McClellan Summation Index
After a substantial decline the week before the NYSE breadth improved last week so the net change from two weeks ago is -58.80. However, remember 1000 is considered to be neutral so the current reading appears tepid, but consistent with a rangebound market.
 
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