Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
For those following the weekly Digests this week?s title should not be a surprise having previously tagged four areas of special concern last week.?Focused on these four, this regular bi-weekly market review includes more charts and less text presuming a picture is worth a thousand words. First the S&P 500 Index (SPX) along with theMcClellan Oscillator Summation Index for market breadth and DJ Transportation Average (IYT) divergences followed by theUS Dollar Index (DX) and ProShares UltraShort 20+ Year Treasury (TBT).
Market Review
S&P 500 Index (SPX) closed the week up 15.88 or +.69% after spiking 20.80 higher Thursdaygoing into June futures expiration settlement at 2117.11 on Friday morning and then reversing to close 11.25 lower. Since futures determine the cash index value, the run up into the Friday morning settlement and then reversing seems a little suspicious. For more on SPX see the chart below.
CBOE Volatility Index? (VIX) up .18 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 tactical professional traders and 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 88% to July and 12% to August as of Friday for an 11.28 % premium shown above. Our alternative volume-weighted average between July and August regularly found in the Options Data Analysis section on our homepage was slightly higher at 12.68%.
Premiums for normal term structures are 10% to 20% while 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 2.26% and then increased to reach 15.80% Thursday before settling at 12.68% all the normal range.
VIX Options
With a current 30-day Historical Volatility of 105.18 and 71.93 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 tradable futures.
Friday the VIX implied volatility index was 73.08 and when compared to the current range historical volatility of 71.93 both the July and August at-the-money option prices appear inline. However, out-of-the-money call options tell a very different story. Volume for the July options were 314,825 contracts including 60,740 July 23 calls with an implied volatility of 130.10 and 430,185 contracts open interest. Several other out-of-the-money calls also traded large volume with increasing implied volatility indicating serious hedging was underway Friday using out-of-the-money calls. For comparison, the July futures contracts, the basis for the July options only traded 74,521 contracts.
S&P 500 Index
The lower upward sloping trendline is the current active trendline from the October 15 low while the upper sloping channel line converges to form a potential bearish rising wedge and since the current prices remain below the active upward sloping trendline, the rising wedge pattern may already be active, if so the downside-measuring objective is down around 1817.
Market Breadth
The McClellan Oscillator Summation Index reported by McClellan Financial Publications declined by another 151.35 last week down to 372.36. If the number of issues declining compared to those advancing defined the market rather than the index value then a downtrend is already well underway while major indexes remain near their highs creating a noticeable bearish divergence. Here is the chart along with the S&P 500 Index.
While the Summation Index, the red and black line usually follows the SPX, divergences are a reason for caution. For example, on 9-5-14 marked A above, the Summation Index peaked at 2834.04 and then SPX turned lower on 9-19-14, B above. Currently it appears the downside momentum began on 4-28-15, C above while SPX continued higher making a new high 5-20-15 at 2134.71. However, look the current wide divergence indicated by the red arrow.
iShares Transportation Average (IYT) down .13 or .1% for the week this ETF tracks the important Dow Jones Transportation Average Index measuring the performance of transportation sector US equities and considered a leading economic indicator. According to the widely followed Dow Theory, the transports and the Dow Jones Industrial Average should move in the same direction while divergences signal a possible trend change from a Dow Theory perspective.
While the downward momentum slowed last week and is now well below the previously defined trading range, it remains well below the four point downward sloping trendline beginning at the March 20 high at 165.
The strong dollar is apparently creating problems for the transports highlighted by a disappointing fourth-quarter earnings report from bellwether FedEx (FDX) as the company missed the earnings estimates and guided lower.
Once it broke decisively below the trading range indicated by the dotted lines above, at the red arrow, a new operative downward sloping trendline, DSTL from the March 20 high at 165, became the active pattern. While the downward momentum has slowed, it needs to close back above the trendline now about 154 to begin turning higher. In the meanwhile, the divergence with the major indexes continues and the divergence resolution record does not favor the major indexes.
US Dollar Index (DX) down .90 for the week or -.95%, the recent decline appears to be helping support the major equity indexes but that could end soon based upon this next chart.
The long-term upward sloping trendline begin with the low on August 18, 2014 while DXY peaked at 100.39 on March, 13, 2015 before turning lower in what could be an Elliott Wave five wave pattern marked above, if so the 5th wave is due soon, see 5? In fact, based upon seasonal patterns, Tom McClellan suggests a turn is due in early July.
ProShares UltraShort 20+ Year Treasury (TBT) was down 1.00 or -2.01% for the week as long Treasury bond prices advanced. An updated chart of our preferred interest rate indicator:
A new upward sloping trendline USTL 1 begins April 17 at 46.47 and should now act as support. If that fails the next upward sloping trendline, USTL 2 from the January 30 low at 38.15 is the next support. In this event, lower interest rates will support equities for a while longer until rates turn higher again.
Summary
Market breadth and DJ Transportation Average Index divergences continue and when combined with the seemingly never ending uncertainty about Greece along with rising interest rate concerns the risk of an overall market decline remains high enough to consider hedging any remaining portfolio risk while S&P 500 Index remains below the upward sloping trendline.