Volatility Trading Digest - Upward Momentum
Volatility Trading Digest - Upward Momentum
While acknowledging perhaps there are better ways to illustrate last week's increasing momentum in the equity markets than Newton's pendulum it does seem to imply the change was rather sudden considering the lingering concerns about the sovereign debt issues in Europe. In our Market Review, we have three of the more traditional ways to demonstrate the improving momentum followed by an update and three trade suggestions.
Market Review
S&P 500 Index (SPX)
Although not yet above the neckline of the larger potential Head & Shoulder Bottom, a well-defined upward sloping trendline can be used to measure the current advance. Two weeks ago, we included the weekly chart showing the long-term trend. This week, in the strategy section below, we have a daily chart showing the current advance from the early October low.
E-mini S&P 500 Futures (ESH2)
For the last two weeks the volume could best be described as low to moderate with the exception of last Friday when it picked up to 2.1 million contracts with the 2.75 point decline, the first decline in 9 trading days, while the open interest remained stable around 2.6 million contracts.
S&P 500 Index Implied Volatility (IVXM)
Since our last market review, the Implied Volatility Index Mean declined from 18.77 to 18.09, while the CBOE Volatility Index (VIX) increased slightly from 20.73 to 20.91.
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 10% to the January contract and 90% to February resulting in the average premium of 3.04 or 14.51% shown above. An alternative volume weighting between January and February results in an 11.88% 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 15.98% compared to premium of 14.87% in Digest Issue 1, our last market review based upon December 30 closing prices. Although the premiums have risen in the last few weeks, they are still below 20%, which is has been the critical level in the past.
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 15.98% compared to premium of 14.87% in Digest Issue 1, our last market review based upon December 30 closing prices. Although the premiums have risen in the last few weeks, they are still below 20%, which is has been the critical level in the past.
VIX Options
With a current 30-day Historical Volatility of 70.92 and 62.20 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 77.49, the IV/HV ratio is 1.09, using the range method for Historical Volatility the ratio is 1.23 while the VIX put-call ratio is extremely low at .10 as Friday's call volume increased three times normal, providing an important warning signal.
CurrencyShares Euro Trust (FXE)
As we explained last week, once the euro moved down below the midpoint of its long term range it is likely to continue lower until it reaches 120 where there is support. Last week after being oversold, it attempted to bounce but returned to the downside on Friday. With the S&P downgrades on Friday after the markets closed, it will probably now accelerate to the downside.
NYSE McClellan Summation Index
Two weeks ago we said Summation Index readings above 600 were needed in order to see a resumption of the long-term trend. In the last two weeks, this indicator increased 378 points, 155.05 during the week of January 6 and then 222.95 last week as the momentum increased. An increasing number to stocks advancing compared to those declining is one of the better ways to define increasing momentum. If this indicator continues higher it increases the probability the long-term trend will resume.
iShares Dow Jones Transportation Average Index (IYT)
The transports are now back in our lineup since they have broken out above the previous resistance at 90 and are now in a well-defined uptrend off the October 4 low at 70.82. From a Dow Theory perspective, the relative strength in the transports is encouraging for the bulls and another positive momentum indicator.
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