After reaching a new intraday high of 2134.71 on May 20 the S&P 500 Index abruptly retreated below the current upward sloping trendline going, as low as 2072.14 on June 9 before rebounding only to reverse and go lower once again fluctuating around the 50-day moving average. While interest rate expectations and the US Dollar Index along with breadth and the DJ Transportation Average divergences continue as major contributors to the weakness old macro concerns resurfaced. Yes Greece returns to the stage once again, just when it seemed like the rules for the ?extend and pretend? game had been settled the risk that Greece will run out of money by the end of the month increased again last week ? Not Greece Again!
Although numerous hedge suggestions, made over the last five years due to the Greek Tragedy, proved mostly unnecessary, there is no reason to ignore an increased threat in the event the situation deteriorates further even though Greece no longer poses a serious contagion risk, the initial market reaction will likely be unfavorable.
Next week our regular bi-weekly market review will update market breadth and DJ Transportation Average divergences along with the ProShares UltraShort 20+ Year Treasury and the US Dollar Index that we are now calling the ?Four Horsemen of the Apocalypse? but this week we have some SPY alternative hedge ideas right after a few more comments.
Market Review
S&P 500 Index (SPX) closed up 1.28 or .06% for the week and once again below the current operative upward sloping trendline from the October 15 low crossing at 2113.96 Friday and below the widely followed 50-day moving average at 2103.26. From a technical perspectives there are to potential patterns to consider, a possible small Head & Shoulder Top from the May 20 high at 2134.71 and a larger more ominous rising wedge that we will detail next week.
CBOE Volatility Index (VIX) down .43 for the week and while day-to-day VIX changes offer little forecasting insight following the VIX futures premium helps since it measures expectations of professional money managers using futures for hedging long portfolio risk.
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 June and 90% to July as of Friday for a 10.57 % premium shown above. Our alternative volume-weighted average between June and July regularly found in the Options Data Analysis section on our homepage was lower at 6.63% suggesting a skew toward the July futures with more time expiration, since Tuesday is the last trading day for June futures.
Premiums for normal term structures are 10% to 20%. Premiums above 20% are unsustainable suggesting a lack of enthusiasm for VIX hedging often occurring around market highs suggesting overbought conditions associated with pullbacks. Alternatively, premiums less than 10% suggest caution and negative premiums indicate oversold conditions. Last week the volume-weighted premiums started Monday at 1.71%, were as high as 10.33% Thursday, closing Friday at 6.63% all in the caution zone.
Market Strategy
Since several important indicators we are calling, the ?Four Horsemen of the Apocalypse? suggest caution. With a ratcheting up of risk from the Greek Tragedy, it seems appropriate to increase portfolio risk hedges since a negotiating error by either Greece or Germany would most likely result in lower European equity prices that will automatically translate into lower US equity prices at least initially.
While there are many alternative hedging strategies available including reducing exposure to interest sensitive sectors like utilities, MLPs and REITs as well as long VIX call options, since the SPY trades with significant volume and narrow bid/ask spreads it makes a good way to hedge portfolio risk.
Portfolio Hedge
SPDR S&P 500 ETF (SPY) before expenses generally corresponds to the price and yield performance of the S&P 500 Index.
The current Historical Volatility is 10.30 and 7.64 using the Parkinson’s range method, with an Implied Volatility Index Mean of 12.10 down from 12.63 the week before. The 52-week high was 23.25 on October 15, 2014 while the low was 8.10 on July 3, 2014. The implied volatility/historical volatility ratio using the range method is 1.58 so option prices are relatively high compared to the recent movement of the ETF. Friday?s option volume was 2,824,052 contracts traded compared to the 5-day average volume of 2,217,220 while the put/call ratio at 1.55 was near the lower end of the 90-day range where lower ratios are increasingly bullish, but considerable put buying for portfolio protection keeps the ratio in a high range.
Near term put spread,
Using the ask price for the buy and mid for the sell the debit would be .91, about 30% of the distance between the strike prices, with a small volatility edge and with slightly positive Vega of .0234 since implied volatility will likely rise when SPY turns lower positive vega adding some additional edge. Use a close back above Thursday?s pivot high at 212.09 as the SU (stop/unwind).
Since it is difficult to get the timing just right, here is an alternative with more time to expiration meaning less time decay,
Once again, using the ask price for the buy and mid for the sell the debit would be 1.23, about 31% of the distance between the strike prices, with a small volatility edge and with slightly positive Vega of .0292 since implied volatility will likely rise when SPY turns lower positive vega adding some additional edge. Use a close back above Thursday?s pivot high at 212.09 as the SU (stop/unwind).
The suggestions above are based on the ask price for the buy and middle price for the sell presuming some price improvement is possible. Monday?s option prices will be somewhat different due to the time decay over the weekend and any ETF price change.
Summary
Renewed fears of a Greek default that never seems to end along with continuing divergences of both market breadth and the DJ Transportation Average along with increased rising interest rate concerns before the Wednesday?s Federal Reserve announcement on US interest rate policy for June, suggests the risk of an overall market decline has risen sufficiently to increase portfolio hedges.