Volatility Trading Digest – Lazy Hazy Days of Summer
Last weeks’ low trading volume was typical for this time of the year as many investors and traders turn their attention to more leisurely activities. With Europe on holiday, there is also less risk of some surprise announcement rattling the markets so equities were able to drift higher on low volume.
In this issue, we review our indicators along with updating the consumer rotation index and then turn our attention to the current low volatility by offering some vega trading thoughts.
S&P 500 Index (SPX)
Unobstructed by the pressure of a declining euro equities were able to drift higher on low volume to finally make a closing high above the Head and Shoulders minimum measuring objective MO at 1404 that began from the June 4 low at 1266.74. The next objective is the April 2 resistance high at 1422.38 where volatility is likely to increase as it struggles to overcome selling at this previous high.
E-mini S&P 500 Future (ESU2)
Open interest reached 2.8 million contracts on July 11 and has remained near this level with just a few days when it closed briefly below. Friday’s preliminary report at 2.87 million contracts seems consistent with the requirement for expanding open interest to sustain the uptrend. Be aware of any sudden decline in open interest as SPX approaches 1422, as it would indicate the uptrend is becoming unstable.? ?
S&P 500 Index Implied Volatility (IVXM)
In the last week, the Implied Volatility Index Mean declined from 14.11 to 12.90, while the CBOE Volatility Index? (VIX) declined from 15.74 to 14.74 and is now approaching the closing low made on March 2 at 14.26.
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 28% to August and 72% to September resulting in the average premium of 3.18 or 21.57% shown above. Our alternative volume weighting between August and September calculates to be a 17.91% premium, although Friday’s August volume was quite low at about one-half the previous week when the day-weighted premium was 16.41 and the volume weighted was 14.63%.
For this short-term indicator the premium to the cash is a SPX sell signal suggesting professional expectations for the cash to increase toward the futures price. In the past premiums in excess of 20%, have usually preceded corrections, although not a precise timing tool it appears to be a good way to measure professional hedging sentiment. Since the front month volume is very low, we are hesitant to draw any conclusions.
Since the CBOE updates the VIX futures term structure during the day an estimate of the current premium or discount is always available. In addition, the data is available on our Advanced Futures Options pages, using VX as the Instrument symbol and CF for the exchange. Compare the options Implied Volatility to the Historical Volatility by setting HV chart to 21 days.
VIX Options
With a current 30-day Historical Volatility of 100.42 and 72.78 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.
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Using the IV Index Mean of 68.19 the IV/HV ratio remains low at .68, using the range method for Historical Volatility the ratio is .94 while the VIX put-call ratio at .57 is in bullish territory for the VIX, and bearish for the SPX since they move in opposite directions. Friday’s volume was 203,577 contracts compared to the 5-day average of 367,390 contracts.
CBOE S&P 500 Skew Index (SKEW)
Designed to measure the purchase of out-of-the-money S&P 500 Index puts that would require a very large downside move to profit from long put positions, an increase of this index indicates a higher probability of extreme down moves. Friday’s close positions this index just below the middle of its 115-125 range since March.
CurrencyShares Euro Trust (FXE)
Since the August holiday season is now underway, especially in Europe, it is unlikely there will be any significant developments in the all important euro FX market. Now in the middle of a 120 -124 trading range, there could be some attempts made to push it around in the current low volume trading environment.
NYSE McClellan Summation Index
In the past two weeks, the NYSE Composite breadth index, one of the most reliable early trend change indicators, resumed advancing last week, reducing the small divergence with the advancing NYSE Composite Index, by gaining 93.12 after declining 35.51 the week before.
iShares Dow Jones Transportation Average Index (IYT)
The potential Head & Shoulders Bottom pattern seems to be morphing into a range between June 4 low at 86.09, the head of the Head & Shoulders Bottom, and the June 19 high at 94.66. While the pattern remains valid until there is a close below 86.09, the range interpretation is more likely until crude oil declines to provide some additional cost pressure relief for this important group.
SPDR Homebuilders (XHB)
As they say, “Close but no Cigar ” since it closed at 22.43 last Thursday. It still takes a close above 22.43 to negate the potential Head & Shoulder Top pattern, with the Head at the May 2 high of 22.43, the neckline at 19.25 with a minimum downside-measuring objective at 16.57. With “risk on” sentiment improving once again (see Consumer Rotation Index Update below) we think it will soon close above the 22.43 resistance barrier.
iShares S&P GSCI Commodity-Indexed Trust (GSG)
After the decline that ended on June 21 at 28.30 this energy heavy index is now advancing along with crude oil and appears to be in the process of making an Elliott 4th wave, which would be consistent with a seasonal crude oil high sometime in August through October. Seasonally crude oil peaks August – September, but in the last five years the peak has occurred in July.