Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
While the old Wall Street adage ?Sell in May and Go Away? appears on the surface to have been misguided, important divergences suggest trouble could be brewing in June. Simply following the S&P 500 Index without watching the interest rate sensitive sectors and the US Dollar Index misses the boat since there are significant battles underway while the major equity indexes are stuck at levels with high valuations.
Our regular bi-weekly market review includes details about developing market breadth and DJ Transportation Average (IYT) divergences along with the ProShares UltraShort 20+ Year Treasury (TBT) and the US Dollar Index (DX) followed by a CBOE Volatility Index? (VIX) hedge suggestion.
Market Review
S&P 500 Index (SPX) ?closed down 14.56 or .69% for the week and importantly below the current operative upward sloping trendline from the October 15 low crossing at 2105.49 Friday and 2109.12 today and below the widely followed 50-day moving average at 2100.53. Friday?s low volume 3.01 point decline in a narrow trading range was surprising since interest rates closed on the high for week following a better than expected nonfarm payroll report.
The actual 55-year June record quashes the value of relying solely on the ?June Swoon? saying since there have been 28 up years compared to 27 down years during periods when many different variables were influencing market direction much like this year.
CBOE Volatility Index? (VIX) was up .37 for the week and while day-to-day VIX changes offer little forecasting insight following the VIX futures premium helps since it measures expectations of professional money managers using futures for hedging long portfolio risk.
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 applied 35% to June 65% to July of Friday for a 9.38 % premium shown above. Our alternative volume-weighted average between June and July regularly found in the Options Data Analysis section on our homepage was noticeably lower at 6.44% suggesting a skew toward the July futures with more time expiration.
Premiums for normal term structures are 10% to 20%. 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 premiums were in the caution zone all week ranging from a high of 9.13% on Wednesday to a low of 4.50% Thursday before the nonfarm payroll report.
VIX Options
With a current 30-day Historical Volatility of 107.15 and 88.80 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.
Friday the VIX implied volatility index was 71.11 and when compared to the current range historical volatility of 88.80 both the June and July at-the-money options appear relatively inexpensive while the July is noticeably lower as measured by implied volatility and consistent with the higher day weighted futures average above.