Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Perhaps a more suitable title would be ?Overbought and Waiting for Italy to Decide.? However, since the results of the Italian referendum should be known by the time this Digest is published, it?s probably better to focus on the rotation underway in the US markets although an options implied volatility perspective on the Euro and the Euro Stoxx 50 might offers some clues, even though the market forecasting record this year has been deplorable. The market review below has more including an interesting crude oil update after the OPEC meeting last week.
Market Review
S&P 500 Index (SPX) ?declined 21.40 points or -.97% for week, after reaching a new intraday high of 2214.10 last Wednesday, but closing lower on the day thereby qualifying as a key reversal, implying a lower low the next day and likely setting off an overbought pullback. Now at support from the previous highs made during August, the next support level down is 2187.50 and then 2150. While it could turn higher at any time odds are it will remain stalled until after the FOMC meeting on December 14.
CBOE Volatility Index? (VIX) advanced 1.78 points or +14.42% for the week. Our comparable implied volatility index mean, IVXM added 1.35 points or +13.53% to 11.33.
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.
Last week the premium declined from a bullish reading of 20.92% to finish the week in the lower part of the still bullish uptrend zone at 13.02% shown above.
VIX Options
The current Historical Volatility of 121.45 and 126.85 using Parkinson’s range method, the Implied Volatility Index Mean, IVXM was 90.21 up from 73.23 the week before.
Euro Implied Volatility Outlook
Although the record for market predictions of important macro events this year has been less than desirable, here is the volatility chart for the euro ETF.
CurrencyShares Euro ETF (FXE)up .65 points or +.63% for the week as it attempts to retrace the rapid decline from November 4, although it had been trending lower since August 18 at 110.73.
The current Historical Volatility of 7.64 and 4.61using Parkinson’s range method, the Implied Volatility Index Mean, IVXM was 11.38 up from 11.07 the week before. Relative to the movement of the euro, options are expensive at 2.47 times the historical volatility.
SPDR Euro Stoxx 50 ETF (FEZ) down .15 points or -.48% to 31.29, in a well defined downtrend since September 8 at 33.93, although much of the decline is attributable to the currency.
The current Historical Volatility of 11.82 and 8.48 using Parkinson’s range method, the Implied Volatility Index Mean, IVXM was 21.98 up from 20.57 the week before. Relative to the movement of the equity ETF, options are expensive at 2.59 times the historical volatility.
Unlike the implied volatility for the euro currency, the equity implied volatility does not suggest the same uncertainty concern before the upcoming Italian referendum that it did in June for the Brexit vote, in the middle of the chart.
Crude Oil
WTI Light Sweet Crude Oil (CL) basis January futures gained 5.62 points or +12.20% after declining just before the OPEC meeting last Wednesday and then turned higher on the announcement of an agreement to limit production to 32.5 million barrels per day.
The weekly Commitments of Traders reports from the CFTC as of Tuesday November 29, shows activity by ?Managed Money,? the group that best correlates with crude oil price changes and arguably the most important. Last week , their net long position increased by just 763 contracts, or 7.04% of the open interest after selling 16,337 long contracts and reducing shorts by 17,100 contracts suggesting a neutral stance near the middle of the range and close to where it was on March 17, 2015 when WTI was 43.39.
Based upon the “Managed Money” position it appers the potential for a further price increase from short covering is limited since their short position was not extreme before the OPEC meeting and the price is back near the highs made in mid October.
For producers it offers the opportunity to hedge production at a higher level during a period of normal seasonal weakness. There is some evidence of this as the December 2017 contract volume increased 2.4 times normal on Wednesday and Thursday closing Friday at 55.03, as the contango declined to 3.35 or 6.50% compared to 5.04 or 11.44% on November 4 when it closed at 49.11.
Summary
Although risk measures appear normal with improving breadth the S&P 500 Index along with other major indexes, appear to have begun pulling back to correct some of their recent advances. For the S&P 500 Index there are well defined areas of support from the previous highs made during August that should form the base for a yearend rally after the December 14 FOMC meeting.