Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Disappointment could be one way to express the feelings of those expecting a Santa Claus rally at yearend as every upside move encountered selling. Since market pundits claim the Santa Claus rally extends into the first two trading days of the New Year, a non-arrival declaration could be premature. However, remember this Wall Street adage.
“If Santa Claus should fail to call, bears may come to Broad and Wall.”
Market Review
S&P 500 Index (SPX) declined 17.04 points or -.83% for the week and -14.96 points or -.73% for the year, after reaching an intraday high of 2134.71 on May 20. A few large capitalization favorites held it up confirming narrowing breadth while masking the underlying weakness in many other stocks. There is more including a chart in the year end review section below.
CBOE Volatility Index? (VIX) up 2.47 for the last week of the year, based on real-time prices of options on the S&P 500? Index, constructed to reflect 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 20 trading days until the January monthly expiration, the day weighting applied 48% to January and 52% to February for a 2.73% premium shown above. Our alternative volume-weighted average between January and February regularly found in the Options Data Analysis section on our homepage was slightly lower at 2.39 %.
While day-to-day VIX changes offer little forecasting insight following the VIX futures premium helps since it measures expectations of tactical professional traders and money managers using VIX futures and options for hedging long portfolio risk.
Premiums for normal term structures during uptrends are 10% to 20% while premiums above 20% are unsustainable suggesting a lack of enthusiasm for VIX hedging often occurring around market highs suggesting overbought conditions associated with pullbacks. Alternatively, premiums less than 10% suggest caution and negative premiums indicate oversold conditions. Last week the volume-weighted premium remained in the yellow zone all week reaching 9.92% Tuesday before closing the week at 2.39%.
VIX Options
With a current 30-day Historical Volatility of 154.63 and 124.84 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 tradeable futures.
Compared to the current range historical volatility of 124.84 both January and February at-the-money options are inexpensive relative to recent movement of the VIX futures. Friday VIX futures volume had yet to be reported, but the options volume was 123,615 contracts compared to the weekly average of 197, 350 contracts consistent with lower trading volume during the last week of the year.
Strategy Idea
As the chances for a Santa Claus rally diminish along with narrowing breadth as some companies do well while others falter within their sectors the use of sector ETFs has become more difficult. Adding in the lack of liquidity in the high yield bond market could take the equity market lower thereby reducing consumer confidence. Further slowing global trade makes it difficult to support the bull case as the New Year begins. Watch the VIX futures premium as an indicator of hedging activity by large portfolio managers.
As for placing so much reliance on technical analysis charts, remember:
“Technical Analysis is a windsock, not a crystal ball.” Erin Heim
Accordingly, the wind could change direction at any time and if the objective is to buy low and sell high here is another thought worth considering.
“Don’t tell me what to buy ? tell me when to buy it.” John Magee
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