Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
After making a 52-week closing low last Wednesday at 11.77 the VIX ended the week well below 13-17 range from March 17 through June 10 before Brexit briefly disrupted market sentiment. After reviewing the data for the last 5 years it appers a return to the mean value would be just under 15 suggesting the current extremely low value is unsustainable. Adding data from the VIX futures premium below supports the view and suggests VIX will soon move back into the range. After a brief market review, a trade suggestion for Silver Wheaton offers an opportunity to test the strength of precious metals against the now advancing US Dollar Index.
S&P 500 Index (SPX) advanced another 13.29 points or +.61% as the uptrend from the June 27 low at 1991.68 continued although the momentum appears to be slowing, however breadth as measured by the ratio adjusted McClellan Summation Index at 1256.15, up 104.04 for the week, remains positive. Watch for a key reversal, another intra-day high with a lower close with increased volume, as the first sign that a retest of the breakout may be underway.
CBOE Volatility Index? (VIX)declined an additional .65 last week, after reaching an intraday low of 11.40 Wednesday, closing at 11.77. Checking the 5-year record shows only two lower intraday lows, the first was July 3, 2014 at 10.28 followed by the second on August 5, 2015 at 10.88. Interestingly both preceded significant rapid advances within brief periods, by July 17, 2014, the intraday high reached 15.38 and by August 24, 2015, it was way up at 53.29. While the current extreme low does not necessarily mean a large advance will soon follow, it does imply a return to the mean around 15, is likely while coinciding with SPX declining to retest the breakout back near 2100.
Based on real-time prices of options on the S&P 500? Index, VIX reflects investors’ consensus view of future (30-day) expected stock market volatility.
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.
With 17 trading days until the August monthly expiration, the day weighting applied 85% to August and 15% to September for a 30.62% premium shown above. Our alternative volume-weighted average between August and September regularly found in the Options Data Analysis section on our homepage was somewhat higher 34.77% while the open interest weighted premium was closer at 31.50%
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 VIX futures and options for hedging long portfolio risk.
The premium measures the amount the futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration. Depending on the time to expiration, premiums for normal term structures during uptrends are 10% to 20% and decline when the VIX advances faster than the nearest future as the market declines and/or the futures decline as the front month expiration approaches. Premiums less than 10% suggest caution and negative premiums indicate oversold conditions when the VIX is higher than the futures and are usually associated with reversals.
After the July futures expired Wednesday, the volume weighted premium now for August and September increased to 26.32% from 19.48% based on July and August futures.
The day-weighted premium at 30.62% above reflects higher future prices on the entire curve along with open interest increasing another .18 % to 470,239 contracts after adding 11% the week before.
Checking the weekly record there were only two times in the last 5 years when the day-weighted futures premium exceeded 30% , the first on March 16, 2012 at 46.26 before SPX declined from 1390.78 to 1278.04 few weeks later and again August 17, 2012 at 33.27 before SPX declined from 1418.16 to 1353.33 by November 15, 2012.
After gold and silver made significant advances since May 31, the rising?US Dollar Index (DX) 97.47 may be about to put them in reverse. Commodity prices especially crude oil and gold have recently been inversely correlated and for gold to maintain the current level or continue higher requires either the correlation to breakdown or for DX to stop advancing. With funds rotating from sector to sector, in and out of risk assets faster than easily understo od by the fundamentals, uncertain macro forces seem more important than earnings reporting now underway.
Accordingly, for those interested in momentum here is an idea to test the strength of gold and silver while keeping a close eye on the US Dollar Index.
Silver Wheaton (SLW) , up .13 points for the week or +.5% and up 7.53 points or +40% from May 31, is a precious metal streaming company with agreements whereby it has the right to purchase, all or a portion of the silver and/or gold production from several high-quality mines for upfront payments.
Typically, no ongoing capital or exploration costs are required and with operating costs historically fixed at approximately US$4 per ounce of silver and US$400 per ounce of gold production benefits from rising silver and gold prices.
Consider this long September call spread although second quarter earnings are scheduled for August 10 after the close, with a consensus estimate of .14 per share on million revenue of 200.51 million.
The current Historical Volatility is 39.09 and 35.26 using the Parkinson’s range method, with an Implied Volatility Index Mean of 44.44 down from 47.16 the week before. The 52-week high was 64.43 on August 24, 2015 while the low was 42.95 on March 30, 2016.
The implied volatility/historical volatility ratio using the range method is 1.26 so option prices are reasonable relative to the recent movement of the stock.
Friday?s option volume was 10,066 contracts with the 5-day average of 12,740 contracts with reasonable bid/ask spreads.
Using the ask price for the buy and mid for the sell the call spread debit would be .87 about 29% of the distance between the strike prices with 42% of the long call price risk hedged by the short call. Use a close back below the upward sloping trendline from the May 31 low, now about 24.50 as the SU (stop/unwind).
Although SPX continued higher and breadth remains favorable momentum appers to be slowing while the US Dollar Index (DX) creates a headwind by advancing once again. Although overbought by many technical measures until an event occurs to change sentiment it can remain overbought although a successful retest of the breakout would add credibility to the long- term bullish view despite fundamental valuations at the extreme.
Summary
After renewing the long-term uptrend from the October 2011, the S&P 500 Index while remaining in overbought territory, shows signs of slowing momentum with an abnormally high VIX futures premium suggesting increased hedging activity by tactical professional traders and money managers. Anticipate a retest back to support around 2100.