Volatility Trading Digest - Follow the Leader
Volatility Trading Digest - Follow the Leader
Most of the earnings reports released so far have been positive, but there seems to be little enthusiasm for higher prices as some closely watched stocks have experienced selling on the reports. We think the likely cause is a market that has gone too far too fast and is looking for a reason to correct the upward trajectory to a more sustainable rate. In the strategy section below, we suggest watching Apple Inc. for clues as to when the upward momentum may resume.
In this issue, we update our market indicators and offer a trade suggestion for Apple's earnings report this week.
Market Review
S&P 500 Index (SPX)
We need to make a technical correction to the important pivot mentioned last week as being the April 11 low at 1358.98. On closer exanimation, we see it should actually be the April 10 low at 1357.38. As the correction continues to develop, the potential complex Head & Shoulders Top pattern could be in the process of defining the height of the right shoulder and could rise above 1400. On the downside, the critical level is the above-mentioned 1357.38, as a close below would activate the pattern suggesting a downside-measuring objective around 1300.
E-mini S&P 500 Futures (ESM2)
As the correction continues developing open interest has remained fairly constant between 2.7 and 2.8 million contracts, however volume has been increasing and is especially noticeable on down days.
S&P 500 Index Implied Volatility (IVXM)
Since last week, the Implied Volatility Index Mean declined from 17.77 to 15.38, while the CBOE Volatility Index (VIX) declined from 19.55 to 17.44.
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 May and 15% to June resulting in the average premium of 2.59 or 14.85% shown above. Our alternative volume weighting between May and June results in a 17.40% premium. Both increased moderately in the past week, the day-weighted from 10.10% and the volume weighted from 7.14%.
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. In the past premiums in excess of 20%, have usually preceded corrections, although not a precise timing tool it does appear to be a good way to measure professional hedging sentiment.
Since the CBOE updates the VIX futures term structure during the day an estimate of the current premium or discount is always available. In addition, the data is available on our Advanced Futures Options pages, using VX as the Instrument symbol and CF for the exchange. Compare the options Implied Volatility to the Historical Volatility by setting HV chart to 21 days.
VIX Options
With a current 30-day Historical Volatility of 95.24 and 86.68 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 Friday's closing option mid prices along with their respective month's futures prices, since the options are priced from the futures.
Using the IV Index Mean of 88.49 the IV/HV ratio is .93, using the range method for Historical Volatility the ratio is 1.02 while the VIX put-call ratio is .25.
All of the Implied Volatilities along with the Historical Volatilities and Greeks for the VIX options based upon the futures prices are on our Advanced Options page, found by clicking on the "market close" link shown near the top of the page.
CBOE S&P 500 Skew Index (SKEW)
Purchasing of out-of-the-money S&P 500 Index puts for downside protection causes this index to increase in value. Since Digest Issue 15 SKEW declined from 120.61 and is in the lower part of its recent 115-140 range, indicating fewer recent out-of-the-money put purchases implying less hedging activity.
CurrencyShares Euro Trust (FXE)
Once again, a brief euro decline found support at 130 and now looks like it is in a range between 130 and 134 and will not likely retest the January 126 low in the near future. This should take the stronger dollar concern off the table for the time being, which should help support equity, commodity, and crude oil prices.
NYSE McClellan Summation Index
Several times in the last few weeks we have highlighted the divergence between the NYSE Composite Index and the number of advancing issues compared to the number of declining issues and this most prescient leading indicator has once again proven correct. Since last reporting two weeks ago, it declined a further 400.64 points and is now approaching the zero mark that would take it into bearish trend territory. It is too soon to declare the current correction will turn out to be a trend change, but the breadth will need to start improving before a sustained uptrend can resume. We urge clicking on the link above and looking at this important breadth indicator.
iShares Dow Jones Transportation Average Index (IYT)
Low natural gas prices are playing a role here since coal demand along with prices are declining as well and the railroads, which represent 31% of this index, depend upon transporting coal. Any further decline in crude oil and gasoline prices will help, but until then the transports will continue to be a drag on the major equity indexes, and a Dow Theory concern.
SPDR Homebuilders (XHB)
The homebuilders closed below the upward sloping trendline from the October 4 low at 12.21 and then turned higher to retest it before declining once again. Since there is considerable support at 20, any close below would not be encouraging for this group or the US economy, as it will place more drag on the major equity indexes.
iShares S&P GSCI Commodity-Indexed Trust (GSG)
We are returning this index to the lineup since it appears to be in well-defined downtrend after making a dramatic high of 36.72 on March 1. Should crude oil join natural gas and accelerate to the downside this index could retest the low made last December at 31.31. Goldman Sachs reduced their commodity outlook to neutral on March 27 just as this index closed below the upward sloping trendline from the December low.
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