Volatility Trading Digest – Introducing Volatility Kings
Anticipating 3Q earnings reports next month we updated our list of underlying stocks that in the past experienced significant increased options implied volatility going into their reporting dates. We are calling them our Volatility Kings and have the list of those reporting in October below.
First, we have a brief strategy comment followed by a check on hedging activity with an update of our VIX futures premium. Next in the Scoreboard section, we report the results of the positions closed at the September options expiration.
Strategy
Without knowing if their announcements were coordinated, Mario, Ben and Wen have succeeded in taking the normal September seasonal decline in equities off the table. After moving to new high for this advance from the June 4 low at 1266.74 to reach 1474.51 on September 14, the S&P 500 Index (SPX) along with most of the other major market indices look overbought and due for a correction, or least a trading range for awhile. After September options and futures expiration that probably supported prices last week and since there is no near term overhead resistance, we expect it will continue higher after a brief correction or pause.
Between now and year-end we think one important influence will be underinvested mutual and hedge funds chase performance since they risk losing assets under management if their year-end performance lags the S&P 500 Index. This could create a broad based momentum rush as managers look for sectors that have not yet advanced in hopes of catching up with the benchmark index by the end of the year.
S&P 500 Index Implied Volatility (IVXM)
At the end of last week, the Implied Volatility Index Mean had declined from 12.69 to 11.31, while the CBOE Volatility Index (VIX) declined from 14.51 to 13.98.
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 85% to October and 15% to November resulting in the average premium of 2.34 or 16.75% shown above. Our alternative volume weighting between October and November calculates to be a 19.89 % premium. Last week the day-weighted premium was 18.35% and the volume weighted was 14.83%. Fridays’ volume was 95,616 contracts as the open interest declined from 427,260 contracts on September 17, due to expiration of the September contract, to close the week at 392,507 contracts.
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, which is now back into the normal range.
CBOE S&P 500 Skew Index (SKEW)
Following up on the chart we presented last week, we note SKEW closed above 130 and above the spike to 129.99 it made on August 21, the day SPX made the key reversal. 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 expectation of an extreme down move. This suggests correction expectations are now quite high.
Scoreboard
We closed our September options positions on Friday for the expiration. We had six remaining open positions and while there is a tendency to say anybody can make money in bull market they all did well except for the VIX hedge we suggested last month that we closed last week for a loss, but that is how hedges are used. The final tally was 7.10 gains offset by the hedge loss of 2.35 based upon one-lot positions.
Volatility Kings
IVXM is Friday’s Implied Volatility Index Mean
Based upon recent previous reporting dates IVXM Est is the estimated Implied Volatility Index Mean it could reach by the next report date using a volatility chart.
IV Est/IV is the ratio between the current implied volatility and the expected implied volatility at the report date.
Straddle is the sum of Friday’s call and put option mid price.
Expires is the month the suggested option expires. However, more expiration dates will be available this week since the September options have expired.
Days is the number of days to expiration for the suggested straddle.