Strategy Ideas
Over the next few weeks, there will be numerous articles published and talk about attempting to foresee economic and market conditions. Based upon the records of leading market pundits and economists we suggest spending more time managing positions and less time attempting to forecast. However, we do think it worthwhile to watch for continuing market sector rotation in the event interest rates continue advancing.
For now profit taking in some momentum favorites that began before year-end seems to be the best place to focus since it may lead to a market correction. From an Elliott Wave perspective, the major indexes and selected leading stocks are approaching minimum 5th wave objectives. This does not preclude further advances but it does suggest the probability of an A-B-C counter trend correction is increasing.
With that thought in mind, here is a hedge suggestion to consider that adds to last week’s rising interest rate idea.
VIX Hedge Suggestion
CBOE Volatility Index??(VIX) Since VIX options are priced from the VIX Futures and the January Futures expire January 21, this should be ample time to see if a correction is underway. In addition, the January at-the-money call at .80 is less expensive in money terms with a .2040 gamma (rate of change of delta), than the February 15 call at 1.25 with a .1223 gamma. Since VIX option trades are short-term a higher gamma is preferable.
One disadvantage of using VIX options is the wide bid/ask spreads. For this suggestion, the January 14 call is .75 bid/.85 ask, which means there is considerable slippage when opening and closing the position.
If a correction is about to begin expect VIX to spike higher and then quickly close lower when the correction appears complete so this position requires close monitoring. Comparing the implied volatility at 61.20 to the both the annual rate of change Historical Volatility of 80.61 and the range Historical Volatility of 63.00 implies the calls are not yet anticipating an advance unlike the Futures premium at 5.32% that is already in yellow light territory.
The suggestion above uses the Friday closing middle prices between the bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
Summary
Unlike last year when equities started the year strong, the opening two days this year have been weak on what appears to be continued profit taking. While two days does not make a trend, we suggest some caution is advisable until the end of this week when there should be a clearer picture.