Volatility Trading Digest - Jackson Hole 2.0
Volatility Trading Digest - Jackson Hole 2.0
After another large decline last Thursday, equities along with other "risk-on" assets appear poised for a relief rally that could come early in the week as the markets begin anticipating and debating what Federal Reserve Chairman Ben Bernanke may deliver in his Friday speech. It was in last year's speech from Jackson Hole when the Chairman unveiled QE2 setting the stage for an equity rally that helped to boost the S&P 500 Index by 32% before reaching a top on May 2, 2011. Although the early comments do not reflect high expectations, unless there is news of more negative developments in Europe chances are we can expect some short covering before the speech, after all nobody knows what he may pull out of his hat. We have more details in our market review along with two trade ideas.
After another large decline last Thursday, equities along with other "risk-on" assets appear poised for a relief rally that could come early in the week as the markets begin anticipating and debating what Federal Reserve Chairman Ben Bernanke may deliver in his Friday speech. It was in last year's speech from Jackson Hole when the Chairman unveiled QE2 setting the stage for an equity rally that helped to boost the S&P 500 Index by 32% before reaching a top on May 2, 2011. Although the early comments do not reflect high expectations, unless there is news of more negative developments in Europe chances are we can expect some short covering before the speech, after all nobody knows what he may pull out of his hat. We have more details in our market review along with two trade ideas.
Market Review
S&P 500 Index (SPX)
The minimum downside-measuring objective of 1145 for the Head & Shoulders Top that we detailed in Digest Issue 28 was completed with the 1119.28 close on August 8. From the key reversal on August 9 we expected to see a rally back to resistance at 1250, however since the fundamentals are not cooperating it appears there will be a test of the August 9 low at 1101.54 sooner than expected.
E-mini S&P 500 Futures (ESU1)
Volume on both Thursday and Friday was considerably more than our high volume marker of 2.5 million contracts, especially since August is a period when volume is usually lower. In addition, open interest expanded again both days, after declining last Tuesday, as the shorts dominated the market. If we see any short covering early next week, open interest should decline.
S&P 500 Index Implied Volatility (IVXM)
Since our last review, the Implied Volatility Index Mean has increased from 16.53 to 36.63, while the VIX increased from 19.53 to 43.05.
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.
For this short-term indicator the discount to the cash is a SPX buying signal indicating professional expectations for the cash to decrease back toward the futures price. This week at -18.93% is the second highest discount we have recorded, exceeded only by last weekís reading at -21.44%.
Readings above 20% are generally a good indication of increased professional hedging in anticipation of an immediate decline while negative readings suggests complacency about protecting long stock positions by buying VIX futures contracts. Low and especially negative readings, like the current one, have been good leading indicators for short-term market advances in the past.
Since the CBOE updates the VIX futures term structure during the day an estimate of the current premium is always available.
VIX Options
With a current 30-day Historical Volatility of 225.11 and 145.27 using the Parkinson's range method, the table below shows 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.
Using the IV Index Mean of 122.41, the IV/HV ratio is .54, using the range method for Historical Volatility the ratio is .84. The VIX put-call ratio was .60.
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.
CBOE S&P 500 Skew Index (SKEW)
When out-of-the money S&P 500 Index puts are purchased for downside protection, the SKEW is designed to increase. From our perspective, the SKEW continues to act more like a contrary indicator.
As an alternative method, consider the skew readings for both the SPX and the VIX below.
- SPX Skew -.3607
- VIX Skew .5444
- Skew Spread .9051
On Monday August 8, the SPX skew was at the lowest 52-week reading at -2.0960, while the VIX was 1.9239 for a combined skew spread of 4.0199 compared to Friday's .9051.
US Dollar Index (DX)
Despite the 10-year Treasury note trading at the lowest yield in thirty years, the dollar index has not significantly increased and appears to be in a 73.50 to 76.50 trading range.
iShares Barclays 7-10 Year Treasury (IEF)
With a striking similarity to the gold chart, the 10-year note looks overbought, selling at a yield of 2.07% having reached as low as 1.97% last Thursday.
NYSE McClellan Summation Index
After three weeks of triple digit declines, our NYSE breadth measure stabilized last week and recorded a slight 2.70 gain, however it is still a long way from zero and even further from 1,000, which is considered neutral.
iShares Dow Jones Transportation Average Index (IYT)
From a Dow Theory perspective, the transports have lost their relative strength and are leading the S&P 500 Index lower reflecting concern that the US economy is slowing. While the S&P 500 Index is still above the August 9 key reversal low, IYT is 1.18 lower than the August 9 low providing encouragement for the bears.
iShares S&P GSCI Commodity-Indexed Trust (GSG)
GSG our proxy for the CRB Index declined and closed below 32 before recovering somewhat on higher gold prices. Now in a well-defined downtrend it would need to close back above 35 to begin reversing the downtrend. Copper at 3.98, basis Sep futures, is showing noteworthy relative strength, having declined from 4.50, it is still within the recent 3.90 ñ 4.50 range.
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