After Thursday’s OPEC announcement that production levels will remain unchanged and Friday’s selling in relatively thin after Thanksgiving market conditions crude oil and the many related exploration and production as well as oil service stocks appear oversold. Accordingly, chances are good for a short-term counter trend reversal in the near future, perhaps even this week.
While lower gasoline and jet fuel prices benefits airlines, restaurants and selected retail they appear overbought and could see somewhat lower prices as they retest Friday breakout levels.
Market Review
S&P 500 Index (SPX) for the week the advance was an additional 4.06 points or .2% even thought the entire energy sector was considerably lower. For several weeks we have been looking for a retest of the breakout above the September 19 high at 2019.26 and weakness in the energy sector could be just enough for a short-term pull back led by the overbought beneficiaries of lower crude oil prices.
Powershares QQQ (QQQ) up 2.14 points and 2.06% for the week the relative outperformance continues with more technology and fewer energy related stocks. For now, there is no sign of attempting to retest the breakout back above 100.56 made on September 19 now just a fading memory along with the unfilled breakaway gap.
CBOE Volatility Index? (VIX) up .43 for the week but up noticeably 1.26 Friday on the slight 5.27 decline of the S&P 500 Index although volume was relatively light Friday.
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 applies 60% to December and 40% to January for a 14.66% premium shown above. Our alternative volume-weighted average between December and January, regularly found in the Options Data Analysis section on our homepage, is slightly lower at 13.95%. Premiums for a normal term structure are 10% to 20%, while premiums above 15% appear to suggest a lack of enthusiasm for VIX hedging. Premiums less than 10% suggest caution and negative premiums are unsustainable suggesting an oversold condition. Last week, the premiums were all above 15% every day except for Friday at 13.95%, back in the normal zone.
Oversold Crude Oil
United States Oil ETF (USO) for those who decided to wait out the OPEC meeting and did not implement the long January 28/26 put spread suggested a few weeks ago,?here is a short-term suggestion conditioned upon a bounce up from the current oversold condition that could occur sometime this week. Look for a key reversal or outside range day on high volume.
The current Historical Volatility is 33.54 and 20.46 using the Parkinson’s range method, with an Implied Volatility Index Mean of 33.31 up from 32.74 the week before. The 52-week high was 35.35 on November 25, 2014 while the low was 13.19 on June 11, 2014. The implied volatility/historical volatility ratio using the range method is 1.63 meaning the option prices are high relative to the movement of the ETF. The?put-call ratio at 2.80 is bearish reflecting considerable hedging activity. In the past year, the ratio exceeded 3 six times. Friday’s option volume was a staggering 286,824 contracts traded compared to the 5-day average volume of 204,600 contracts so there is good liquidity as reflected in the reasonable bid/ask spreads.
On the expected oversold rebound, consider this January risk reversal.
Using the ask price for the buy and middle for the sell, the debit is .59 as it hedges both changes in implied volatility and time decay with the equivalent of a 100 share position at the current ETF price. This is a short-term trade, once opened, look for the next reversal for a close that could come within just a few days. Although overwhelmed by selling this year, based upon the seasonal pattern for the last 5 years, prices in December are usually firmer, followed by lows that should occur in January.
The suggestions above use closing ask prices for the buys and middle prices for the sells presuming some price improvement from indicted prices is possible for liquid stocks. Monday’s option prices will be somewhat different due to the time decay over the weekend and any price change.
Summary
After Thursday’s OPEC meeting crude oil and the entire energy sector sold off ferociously into oversold territory while those groups benefitting from lower energy prices broke out to the upside and now appear overbought. Accordingly, look for moderate corrections of both groups over the next few days that could also extend to the major averages such as the S&P 500 Index.