Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
This week we review the Rising Wedge story along with a look at the Volatility Kings? scheduled to report earnings this week along with our regular report on the VIX futures premium. Then a brief note with a chart for the latest WTI crude oil Commitment of Traders report.
Review Notes
S&P 500 Index (SPX) declined 20.76 points or -.96% for week. The rising wedge identified last week in Digest Issue 39 “Likely Rising Wedge [Charts]” met its downside-measuring objective and then attempted to turn higher as expected when a continuation pattern meets its objective MO. Now chances are Support at 2120 will hold awaiting the development of a new pattern.
CBOE Volatility Index? (VIX) up 2.64 points or +19.58% after reaching an intraday high of 17.95 Thursday as SPX met the downside rising wedge objective.
According to the CBOE, 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 just 2 trading days until the October monthly expiration, the day weighting applied 10% to October and 90% to November for a 7.02 % premium shown above. Our alternative volume-weighted average between October and November regularly found in the Options Data Analysis section on our homepage was slightly lower at 5.31% while the open interest weighted premium was 5.66%.
VIXThe 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.
Volatility Kings 3Q Earnings
Here are four Volatility Kings reporting this week.
The implied volatility index IVXM for both INTC and MSFT have not reached last quarter?s high, Last Q but there are two more days for INTC and three more for MSFT. Both ratios Ratio of Implied Volatility to Historical Volatility based upon the range method, PHV suggest the width of the possible price distribution will be normal. However, for NFLX at 2.25 the IV/PHV ratio suggests the potential for another large move or even another gap.
From Friday?s Best Calendar Spread idea in the Rankers and Scanners section of our home page here is one more that should have been included in the 3Q Volatility Kings? list.
Friday the scanner showed this Calendar Spread idea:
Buy Feb 17 32 Call at 2.30 IV 30.30
Sell Nov 16 32 Call at 1.28 IV 37.28
Determined solely by the implied volatility differentials shown above between options with two different expirations, calendar spreads, also called time spreads are used for quarterly reporting by selling the near term option with higher implied volatility and buying the same strike price in the deferred month with a lower implied volatility. However, since this position will have short gamma or the rate of change of delta, any large move of the underlying stock on the report date will result in a loss and the combination of the rising implied volatility index along with the high IV/HR ratio suggests the risk is high. For EBAY the Implied Volatility Index is already above last quarter?s high and the IV/PHV Ratio at 2.10 suggests the potential for a large move confirmed by the gaps on the price chart for the last year.
Crude Oil
WTI Light Sweet Crude Oil (CL) 50.35 basis November futures advanced .54 points or +1.08 % for the week after reaching an intraday high of 51.60 on Monday October 10 and then reversing.
The weekly Commitments of Traders reports from the CFTC as of Tuesday October 11 provides insight into the activity of the participants that determine the market reference price of crude oil, using the Disaggregated Commitments of Traders – Options and Futures Combined as explained in Digest Issue 31 “Rounding Top & Crude Oil [Chart].”
As of Tuesday October 11, ?Managed Money? continued to push prices higher by adding 6,187 long contracts while reducing short contracts by 27,252 for a net long position increase of +33,439 or up to 10.40% of the open interest from 9.52% last week, shown in the chart from March 17, 2015 when crude oil was 43.39. In addition, this week ?Other Reportables? helped by doing the same adding 13,760 longs and reducing shorts 9,566 for a net position increase of +23,326.
Managed Money only chart:
Although prices pulled back slightly Wednesday and Thursday, the ?Managed Money? group, the one that seems to have the most influence on prices at the margin, appers to remain bullish.
StrategyWhat a difference a week makes as interest rates and the US dollar index advanced once again on rising expectations of an interest rate hike in December. Citing disappointing trade data from China on Thursday was another reason for the S&P 500 Index decline. The biotech sector added to the woes as Democratic gains in Congress could mean more regulatory and legislative actions in an effort to slow price increases. Finally, breadth has been declining since July 22 and the downward momentum increased this week. Caution as suggested by the low VIX futures premium at 7.02% above, seems about right.
Summary
Despite headwinds from rising interest rates, the US dollar index and concerns about the US Presidential election that began influencing the S&P 500 Index through the biotech and other sectors, support at 2120 held but the rising VIX along with lower VIX futures premium going into an important earnings reporting week suggests caution.