We begin by updating our indicators while checking on the progress of the equity uptrend. Then we offer a few words of caution on this first day of April, also known as April Fools’ Day followed by a conditional VIX hedge idea and status report from one of last week’s ideas.
S&P 500 Index (SPX)
The financial media celebrated the new high, but hold on a minute, it did not close above the October 11, 2007 high at 1576.09. From a technical perspective, it is easy to understand the celebration was a bit premature since there is a difference. Some selling at the old high could be expected so now the challenge is to close above that old high, which is likely having just broken out of what could be described as an imperfect triangle consolidation pattern with an upside measuring at about 1582.
From an Elliott perspective, this is the third momentum wave with a well-defined upward sloping trendline confirmed by public attention from news media reports about the new highs. It is during third waves that everybody wishes they were long the market much like last year. The fourth wave, called profit taking, is the counter trend correction so be prepared with a hedging plan since today is the first day of April as further explained below.
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.
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The day weighting applies 60% to April and 40% to May for an average premium of 16.05% shown above. Our alternative volume weighting between April and May is 16.22% placing both near the middle of the normal range.
iPath S&P 500 VIX Short Term Futures ETN (VXX)
The five-day average volume, not the week ending volume due to the Friday holiday, was 46 million shares down substantially from 70.3 million the week before.
VelocityShares Daily Inverse VIX Short Term ETN (XIV)
The 5-day average volume, once again not the week ending volume due to the Friday holiday, for the inverse was 13.8 million shares down from 19 million shares the week before making the VXX/XIV volume ratio 3.34 compared to 3.69 the week before.
When the term structure is in contango, or it slopes upward over time, the advantage goes to a long XIV position since it represents a short futures position and VXX continuously sells the near term contract and buys the next longer term contract at a higher price. On Thursday the spread between April and May was -1.37, while the May – June spread was -1.01.
VIX Options
With a current 30-day Historical Volatility of 148.64 and 106.49 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.
Using the IV Index Mean of 67.74 the IV/HV ratio is .46, using the range method for Historical Volatility the ratio is .64. While historical volatility usually exceeds the implied volatility, the current spread is noticeable. In the past the difference narrowed as the historical volatility declined to meet the implied volatility as reflected by the ratio returning closer to 1.00 and even briefly declining below the implied volatility. Look at our Basic Options volatility chart.
The VIX put-call ratio at .25 is bullish for VIX, but not for the SPX with a more modest put-call ratio of 1.50, down from 1.90 the week before, since they move in opposite directions.
The CBOE equity only put-call ratio at .62 was just slightly lower than the week before at .69 making the spread between the VIX put-call ratio .37, up from .28 the week before. As the CBOE put-call ratio increases it becomes more bearish while the VIX put-call ratio is more bearish (for the SPX) as the ratio declines making the spread between them wider.
CBOE S&P 500 Skew Index (SKEW)
SKEW measures the purchase of out-of-the-money S&P 500 Index puts that require a very large downside move to profit from long put positions. An increase of this index indicates greater expectations for an extreme down move. When we last reported in Digest Issue 11, it was in the upper quartile of the 113-130 range and very near the important 130 level that it reached on February 15 just before the last correction. Since then it has declined back toward the midpoint of the range.
US Dollar Index (DX)
The dollar advance continues but the momentum seems to have slowed somewhat as it approaches 84 where it turned lower last summer. Interestingly, Deutsche Bank recently released a report saying the dollar tends to follow long-term cycles lasting 6-10 years and they expect it has now entered a sustained multiyear uptrend supported by US growth and other macro economic factors. This seems consistent with our remark from two weeks ago, “Until just recently, a lower dollar was associated with higher equity prices, but they now appear to be going in the same direction and may reflect expectations for better economic conditions and higher interest rates in the future.”
iShares Dow Jones Transportation Average Index (IYT)
In addition to being an important Dow Theory confirming indicator, the transports deserve close attention as a leading economic indicator. With its sensitivity to the economy, we suggest checking the transportation index before making any market direction decisions.
NYSE McClellan Summation Index
Since our last market review two weeks ago, in Digest Issue 11 the breadth indictor declined 78.77 points as the broad market consolidated. The lagging breadth divergence continues to be a concern. Ideally, they should be advancing at the same pace.