Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
In addition to the widely known holidays occurring this time of the year there are also some related tendencies that occur in the financial markets as well. For example, crude oil usually firms up in November and December as colder weather arrives in the northern hemisphere on increased heating demand. In addition, the euro usually gains against the dollar. This year both are uncharacteristically weak. Finally, equities are usually up in both November and December, and this year is no exception.
Market Review
S&P 500 Index (SPX) at another closing high the gain for the week was 7.81 points or .4% on moderate volume despite the better than expected payroll report Friday that has previously been known to cause selling on interest rate jitters. Not so this time, as any interest rate hike fears have been overcome by seasonal strength, at least for now and probably until year end. The anticipated retest of the breakout above the September 19 high at 2019.26 may have come Monday with the 14.12 decline back to 2,053.44 and this may be all we can expect for now.
iShares Russell 2000 (IWM) smaller capitalization stocks did slightly better advancing 1.00 point or .86% for the week. The Stock Trader’s Almanac reports “Small caps come into favor during November, but don’t really take off until the last two weeks of the year.” If so, last week’s outperformance could be the first as the smaller capitalization stocks play catch up to the overbought large caps. A close above the July1 high of 120.97 would generate a lot more enthusiasm for equities going into year-end.
Powershares QQQ (QQQ) with more technology and fewer energy related stocks it declined .63 points or .59% underperforming both SPX and IWM as technology was one of the weaker groups last week exceeded only by even weaker Consumer Staples. For now, there is no sign it will make any meaningful attempting to retest the breakout back above 100.56 made on September 19 along with the unfilled breakaway gap.
CBOE Volatility Index? (VIX) closing down for the week by 1.51 points, again back below 12 the decline confirms the new closing high for the S&P 500 Index.
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.
The day weighting applies 65% to December and 35% to January for a 24.48% premium shown above. Our alternative volume-weighted average between December and January, regularly found in the Options Data Analysis section on our homepage, is slightly lower at 20.29%. Previously we suggested premiums for a normal term structure were 10% to 20%, while premiums above 15% are unsustainable suggesting a lack of enthusiasm for VIX hedging and last week they were the highest for a long time. Premiums less than 10% suggest caution and negative premiums indicate an oversold condition. On the modest pull back in the S&P 500 Index Monday, the premium was 12.02% the lowest for the week while Friday’s close shown above was the was the highest and well into the overbought red zone. However, based upon seasonal momentum it may continue in overbought territory until year-end.
VIX Options
With a current 30-day Historical Volatility of 75.25 and 79.06 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 range historical volatility of 79.06 the December options slightly expensive while the January option prices are about right.
CBOE S&P 500 Skew Index (SKEW) measures the purchase of out-of-the-money S&P 500 Index puts that require a very large downside move to profit from long put positions. An increase of this index indicates greater expectations for an extreme down move. The CBOE explains further, a Skew value of 100 means the perceived distribution of S&P 500 log-returns is normal so the probability of outlier returns is negligible. As Skew rises above 100, the left tail of the distribution acquires more weight increasing the probability of outlier returns.
Friday’s close of 131.41 is just above the range midpoint providing no useful information about increased put buying by those anticipating an overbought pull back. Watch for a close back above 140 as a contrarian signal from out-of-the-money put buyers.
Market Breadth
For the week the McClellan Oscillator Summation Index of market breadth reported by McClellan Financial Publicationsdeteriorated by 95.99 points creating a slight divergence with the S&P 500 Index at a new closing high. Perhaps this is another reason to expect an overbought correction in the near future.
US Dollar Index (DX) nothing seems to slow the advance including the year-end seasonal tendency favoring the euro. The Stock Trader’s Almanac reports the history. “In the short fifteen year history of the euro currency, the market seems to make a bottom around the third week of October, then we see a tendency for price gains against the U.S. dollar by yearend.” So far this year there is no sign of euro strength as the dollar index has now closed above the June 7, 2010 high of 88.71. Dollar strength has been negative for commodities especially crude oil. A few weeks ago, we?included a chart comparing?PowerShares DB US Dollar Bullish ETF (UUP) and United States Oil ETF (USO).
Usually crude oil firms up in November and December as show in the USO seasonal chart below.
However, this year crude oil continues lower and the US dollar continues higher.