Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
The non-farm payroll report released Friday was much better than expected, much higher than most, if not all economist were expecting thereby greatly increasing the probability the Federal Reserve will finally hike interest rates next month. Preferring data without seasonal adjustment Steven Hansen at Econintersect boldly said, “Non-seasonally adjusted non-farm payrolls grew 655,000 – the best this century.”
Following our regular bi-weekly review, this week?s Digest rearranges the order of the “Foremost Six” in response to the apparent change of circumstances.
Market Review
S&P 500 Index (SPX) advanced 19.83 or +.95% for the week. The double bottom upside measuring objective at 2172 remains the target, but first sector rotation and resistance in the 2050 -2100 range from July 27 to August 20 around the long-term upward sloping trendline will likely slow the upward momentum from the September 29 low at 1871.91.
CBOE Volatility Index? (VIX) down .74 for the week, 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 12 trading days until November monthly expiration, the day weighting applied 60% to November and 40% to December for an 11.65% premium shown above. Our alternative volume-weighted average between November and December regularly found in the Options Data Analysis section on our homepage was slightly higher at 11.76%.
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 began at 14.20% Monday, declined to 8.40% Thursday before closing Friday at 11.76%.
VIX Options
With a current 30-day Historical Volatility of 104.97 and 105.37 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.
Compared to the current range historical volatility of 105.37 both November and December at-the-money options are inexpensive relative to recent movement of the VIX futures. Friday VIX futures traded 193,360 contracts while options on the futures traded 502,692 contracts, both higher than the previous week.
Foremost Six Update
In last week?s order of perceived significance:
ProShares UltraShort 20+ Year Treasury (TBT)
US Dollar Index (DX)
Market Breadth
China A-Shares ETF (ASHR)
United States Oil (USO)
iShares Transportation Average (IYT)
Expanding on five of the top six:
ProShares UltraShort 20+ Year Treasury (TBT) up 2.51 or +5.76% for the week gapping up at the open Friday after the non-farm payroll report but still below the high of 47.38 made on September 16. The other interest rate indicator to watch:iShares 7-10 Year Treasury Bond (IEF) 105.37 down 1.65 or -1.54% for a yield of 2.33% up 9 basis points or +4.02% Friday. While the IEF uptrend from the July 13 low was broken on November 2, as it gapped lower, it needs to decline below 104.36 or a yield of 3.20% to confirm the likelihood that higher rates will continue higher.
US Dollar Index (DX) up 2.22 or +2.29 for the week ripping through the previous August 7 high of 98.33 on Friday putting downward pressure on commodities, perceptible in crude oil and very noticeable in gold as (GC) December futures declined 15.30 or -1.39% to 1,088.90 and while the % decline did not equal the % gain in interest rates, gold could soon be back to the previous lows seen in late July and early August. If Dec gold closes below the July 24 low of 1,073.70, now 15.20 points lower, it will confirm the stronger dollar scenario.
Market Breadth The McClellan Oscillator Ratio Adjusted Summation Index reported by McClellan Financial Publications, available at StockCharts.com symbol $NYSI advanced 90.69 points last week to 503.10 slightly above 500, the level needed to confirm a resumption of the long-term uptrend according to Tom McClellan. Any further continuation along with rising interest rates and a stronger dollar could indicate an improving economy despite weak manufacturing and exports, but construction spending is up 14.1% year-over-year, much faster than the economy in general.
China A-Shares ETF (ASHR) up 2.49 points 7.01% for the week and up 31.8% from the August 26 low of 28.84. Interestingly the Shanghai Composite continued higher despite Monday?s report that the October PMI index missed expectations at 49.8 while final Caixin PMI improved to 48.3 from 47.6, but remained below 50.0, indicating continued contraction. However,Tuesday Xi Jinping announced the Communist Party had set a 6.5 percent target for annual economic growth from 2016 to 2020 and the Shanghai Composite responded Wednesday gaining 4.31%. See the trade idea below.
United States Oil (USO) as a proxy for WTI Crude Oil declined .58 or – 3.92% for the week while the December WTI futures declined 2.30 or – 4.94% closing at 44.29.
Updating the CFTC Commitment of Traders report for November 3 shows the ?Managed Money? group reduced their short positions by 17,395 contracts while increasing longs by 11,366 thereby increasing the net long position by 28,761 contracts pushing cash crude up to 47.94 on November 3. Since the price has now declined from that level, they must have been selling again later in the week.