Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Until recently ad hoc reviews of various indicators seems adequate since the markets were in bull mode after the election. However, since the week of March 6, that’s no longer true as first noted two weeks ago. There were several important examples of “Buy buy the rumor sell the news” activity going into the non-farm payroll report on Friday March 10. Then last week the S&P 500 Index closed below the upward sloping trendline ending the “Trump” trade. A more extensive indicator review follows including crude oil from the perspective of the latest Commitments of Traders report from the CFTC.
S&P 500 Index (SPX) declined 34.27 points or -1.44% for the week closing last Tuesday below both the upward sloping trendline, USTL from the November 4 low and the first support at 2350. While still above the 50-day moving average at 2330.56, the next support is down at 2300 and then 2275 going all the way back to December 13.
CBOE Volatility Index® (VIX) advanced 1.68 or +14.89 % for the week while the comparable IVolatility implied volatility index mean, IVXM 10.55 gained 2.50 or +31.06% reflecting last week’s pullback.
Here is the Implied Volatility Index Mean, IVXM for the last three months showing Fridays close at 10.55 the highest since December 30, 2016 at 11.40.
The VIX chart
VIX Futures Premium
The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second months.
With 17 trading days until the April expiration, the day- weighted premium between April and May allocated 68% to April and 32% to May for a 8.65% premium the lowest since November 4, 2016 at -15.15% reflecting a higher VIX.
The 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.
In the past premiums below 10% usually preceded further declines as the VIX advances faster than the futures.
The US Dollar Index (DX) & (DXY) down -.86 points or -.86% for the week
A few weeks ago included the mention of a possible Head & Shoulder Top underway see Left Shoulder, LS Head, H and Right Shoulder, RS above and now it’s just above the Neckline, NL at 99 that would activate the pattern with a downside measuring objective at 95 marked MO above.
iShares 20+ Year Treasury Bond (TLT) gained 2.24 points or +1.89% for the week possibly in the process of forming an Elliott 5th Wave bottom, see the waves marked 3, 4, and 5 below.
iShares Transportation Average (IYT) declined 4.28 points or -2.59% for the week . On Tuesday March 7, before the nonfarm payroll report Friday March 10, it closed below the upward sloping trendline that began on October 26, 2016 at 141.68. Then Thursday March 9, it closed below the 50-day moving average shown on the chart below. Using this indicator, it appers selling preceded the payroll report news, selling into the strength expected from the report the next day creating a Dow Theory divergence.
Market Breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that factors out the number of issues traded, and reported by McClellan Financial Publications , declined 98.46 points for the week closing at 222.25. It closed below its 50- day moving average on Tuesday March 7 providing further confirmation that selling was underway before the nonfarm payroll report.
WTI Light Sweet Crude Oil (CL) basis May futures declined again last week, lower by 1.34 points or -2.72%.
The United States Oil Fund ETF (USO) 10.09 chart below shows crude oil has given up all of its “Trump” trade gains from November.
From the Disaggregated Commitments of Traders – Options and Futures Combined report as of March 21, “Managed Money,” the group that best correlates with crude oil price changes and arguably the most important, continued selling by reducing longs -15,536 contracts and increasing shorts -12,662 for a net change of -28,197 contracts or 9.05% of open interest from 9.46% the week before. “PMP” (Commercials) added another 6,038 long contracts while reducing their shorts by +11,814 once again offsetting a good portion of “Managed Money,” selling as the March contract expired. Until “Managed Money,” reduces selling pressure, prices will remain under pressure and so far they seem content with lower prices. The two-year chart below shows they increased their net long position early in the year after the OPEC and NOPEC production agreement and are now unwinding. In the past, March is when they began increasing their position.
SPX closed below its upward sloping trendline, as well as first support at 2350 confirming the end of the “Trump” trade at least for now. The next test will come at 2300, the second support and then 2275. While the indicators above are certainly negative, the current decline could be no more than an overdue pullback soon to be reversed like many others since the March 2009 bottom. Perhaps the proverb, it’s always darkest just before the dawn will hold true once again.
Equities and the US Dollar Index began turning lower and Treasury Bonds began turning higher before the nonfarm payroll report March 10 suggesting the interest rate hike announced March 15 means increased risk due to a changing investment landscape from extreme monetary accommodation to a tighter monetary policy that will slow the economy. Alternatively, it could just be more rotation out of the leaders into lagging sectors. For the likely answer, watch key support levels for the S&P 500 Index.