Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Updating the January Barometer, also called the January Effect adds a higher January close, the first since 2014. According to the Stock Trader’s Almanac January’s S&P 500 Index close, up or down determines the likely direction of the for the year. Adding last year’s up close to the record puts a “Wrong” in the result column, but the higher January close this year puts the probability for a higher year-end close at 90% ending a three-year string of lower January closes.
While this indicator produces mixed results for the years when January closes lower, the record for predicting higher closes for the years when January closes higher is 90% going back to 1950, based data from the Stock Trader’s Almanac. Since 2011 was almost flat, it was not included in the up year column when calculating the probability. Since 2008, this indicator has been “Wrong” five out of nine years, but the up January close record should comfort the bulls.
S&P 500 Index (SPX) added 2.73 points or +.12% for the week after breaking down Monday and creating a potential island top as could be expected after a mostly bullish review in Digest Issue 5 “Smooth Sailing” [Charts] last week, the SPX immediately ran into some unexpected stormy weather that then seemed to fade away by the end of the week as it advance back up and closed the breakaway gap thereby diminishing the significance of the possible island top. Now back above the current upward sloping trend line and challenging the recent January 26 intraday high at 2300.94, the focus now turns to another possible breakout or alternatively a breakdown. On the downside, there is considerable support at 2275 then 2212 and 2185.
CBOE Volatility Index® (VIX) increased .39 or +3.69% for the week after making an unusual intraday low of 9.97 Wednesday and then closing at 11.81. By the end of the week, the comparable IVolatility implied volatility index mean, IVXM also advanced slightly +.19 or +2.33%. While currently bullish, be aware of the tendency to return to the mean near 17.
VIX Futures Premium
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. The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second months.
With 7 trading days until the February expiration, the Day Weighted premium between February and March allocated 35% to February and 65% to March for an upbeat 22.36% premium in the bullish zone.
The current Historical Volatility of 79.21 and 81.35 using Parkinson’s range method, the Implied Volatility Index Mean, IVXM was 87.94 up from 79.84 last week. However, there remains a significant difference between the call implied volatility at 120.19 and put implied volatility at 55.69 suggesting considerable VIX options hedging on 573,848 contracts traded Friday. Here are charts for the last 6 months.
High IV/HV Ratio
As a reminder to those looking for trading ideas and may not be familiar with our website, we offer several ideas located in the “Rankers and Scanner” section of our home page as a regular feature not requiring a premium subscription. First, there is a link to the “Top 200 stocks by volume/open interest” and then the “Top 5 stocks by implied volatility change.” Clicking on the second link shows the Advanced Ranker Sample of the top and bottom five stocks in four categories. From Friday’s sample here is number 2 ranked High Implied Volatility/Historical Volatility Ratio.
iShares iBoxx $ High Yield Corporate Bond ETF (HYG) declined .13 points or -.15% for the week after reaching an intraday high of 87.69 on January 27 and then trading down to 87 last Wednesday. Now below the upward sloping trend line from the November 14 low it looks like it will attempt to return to the trend line and thereby make a new high as the US Dollar Index declines while interest rates on Treasury Notes and Bonds are stable or decline.
The current Historical Volatility is 2.88 and 2.73 using the Parkinson’s range method, with an Implied Volatility Index Mean of 6.67 up from 6.53 the week before. The 52-week high was 17.13 on February 8, 2016 while the low was 6.03 on January 26, 2017. First the volatility chart followed by the price chart.
While the implied volatility has declined the historical volatility declined faster as the trading ranges narrowed when it traded in a tight 87 – 87.50 range.
The implied volatility/historical volatility ratio using the range method is 2.44 so option prices are expensive relative to the recent movement of the ETF, but both measures are at or near 52 week lows. Friday’s option volume was 43,318 contracts with a 5-day average of 70,530 contracts and reasonable bid/ask spreads.
Consider this synthetic long call idea.
Using the bid for the sell and mid for the buy the credit would be .62. Use a close back below support at 87 as the SU (stop/unwind).
Monday’s option prices will be somewhat different due to the time decay over the weekend and any price change.
After a shaky start last week, the S&P 500 Index rebounded Friday closing the breakaway gap that formed a potential island top. Now back above the upward sloping trend line and challenging the recent high the likely direction is up unless upset by a macro event or disappointing earnings reports. The current low implied volatility environment offers opportunities for relatively low-cost option strategies for long positions or short hedging strategies.