Volatility Trading Digest: VIX Futures Pressure Relief
Volatility Trading Digest: VIX Futures Pressure Relief
While last week's minor correction in the S&P 500 Index seemed to relieve some of the apparent overbought pressure that had been building in the VIX futures premium we are not convinced it was enough. We make the case for an additional decline in the market review and strategy sections below. As a result, we offer another hedge suggestion and then review all the trade suggestions made last week in our update section.
Market Review
S&P 500 Index (SPX)
Last week the second long anticipated correction began after reaching a new high of 1414 on Monday, it followed by making lower lows and lower highs for the next four days, although Friday's close was higher than Thursday's the trading range on Friday was lower. We think there is good chance it will continue lower to retest support at 1378.04 from February 29, which would also be support from the upward sloping trendline that began with the November 28, 2011 low at 1169.29. We think a retest of the upward sloping trendline is likely. The next support is then 1370.58, the previous high made on May 2, 2011. A close below this second support level would put the current uptrend in serious doubt.
E-mini S&P 500 Futures (ESM2)
With the expiration of the March contract, June the new front month expires on June 15. After the normal contract rollover volume surge open interest is now back into the normal range with Thursdays' open interest reported at 2.7 million contracts as trading volume remained low all week.
S&P 500 Index Implied Volatility (IVXM)
Since last week the Implied Volatility Index Mean increased from 12.54 to 12.84, while the CBOE Volatility Index (VIX) increased from 14.47 to 14.82.
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 applies 85% to April and 15% to May resulting in the average premium of 2.66 or 17.95% shown above. Our alternative volume weighting between April and May results in a 21.55% premium, still above the 20% caution mark.
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. Premiums declined with last week's correction, the day-weighted declined from the highest premium recorded to date last week at 46.26%, to 17.95%, while the volume weighted also declined from 33.22% to 21.55%. As a further indication that the hedging pressure declined to some extent, the open interest also declined from Monday at 355,393 contracts to 320,215 on Thursday.
VIX Options
With a current 30-day Historical Volatility of 100.22 and 82.43 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 81.80, the IV/HV ratio is .82, using the range method for Historical Volatility the ratio is .99 while the VIX put-call ratio was .95.
CBOE S&P 500 Skew Index (SKEW)
The purchase of out-of-the money S&P 500 Index puts for downside protection causes this index to increase in value. Last week in Digest Issue 12, we noted three days when it increased above the previous all-time high range of 130, indicting active index put buying. Now back below the previous cautionary high range between 128 and 130 this indicator also suggests some pressure relief for the S&P 500 Index, although it remains in the upper half of its range since beginning on February 23, 2011.
CurrencyShares Euro Trust (FXE)
After it looked like the next stop for the euro was 126, it found support at 130 and turned higher. Now it looks as if it will attempt to return and test the upward sloping trendline defined by the 126.33 low on January 13 and the 129.53 low on February 16. A failure at that level would be the signal to expect a retest of the 126 low. In the meanwhile, the euro rebound last week helped equities and crude oil.
NYSE McClellan Summation Index
As a further confirmation that the current correction is not complete, our NYSE advance-decline indicator continued lower again with another 146.60 point loss since we last reported in Digest Issue 11 as the downside momentum accelerated again last week. As we have noted several times the divergence between the NYSE Composite Index and the number of advancing issues compared to the number of declining issues has been a good leading indicator of trend changes. While it is too soon to declare the current correction will turn out to be a change in trend, we continue to urge watching this indicator carefully.
iShares Dow Jones Transportation Average Index (IYT)
The transports have been having trouble since February 10 when the IYT closed below our upward sloping trendline from the low last October. When FedEx reported better than expected earnings their shares declined -3.5% because they also said they were lowering their worldwide economic growth forecast to plus 2.3% for the year, down from the previous forecast of +2.9%. Unless they get some help from declining crude oil and gasoline prices, which is unlikely since this is the seasonally strong time of the year for energy prices the transports will continue to be a drag on the major equity indexes, clearly a concern from a Dow Theory perspective.
SPDR Homebuilders (XHB)
With the new high made on March 16 at 21.87, we have a new upward sloping trendline from the October 4 low at 12.21. Friday's lower low and lower high along with along with lower close on extremely high volume suggests it will soon test the new upward sloping trendline at 20. We have more in our KB Home (KBH) 10.29 update below.
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