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After breaking out above its six-week trading range it looks like Smooth Sailing for the S&P 500 Index. Our market review provides supporting details including the VIX futures premium, and VIX options as well as a WTI Crude Oil update from the perspective of the Commitment of Traders report from the CFTC.
Market Review
S&P 500 Index (SPX) jumped 23.38 points or +1.03% for the week after breaking out of a six-week trading range that began December 8. With new closing highs a new upward sloping trend line, USTL from the November 4 low becomes the operative indicator to watch for any attempt to retest support at 2275. Indeed it appears the entire trading range between 2250 and 2275 will now likely provide support. Then there is support again at 2212 and 2185.
VIX Spotlight
CBOE Volatility Index? (VIX) declined .96 or – 8.32% lower for the week reaching the lowest close since the July 3, 2014 low at 10.28. The comparable IVolatility implied volatility index mean, IVXM also made another bullish 52-week low at 8.15. However, from a regression to the mean perspective, be aware..
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 12 trading days until the February expiration, the Day Weighted premium between February and March allocated 60% to February and 40% to March for a bullish 24.48% premium in the middle of the bullish zone, as the VIX made another 52-week low.
VIX Options
The current Historical Volatility of 70.33 and 68.38 using Parkinson’s range method, the Implied Volatility Index Mean, IVXM was 79.84 up from 78.20 last week. However, there is a significant difference between the call-implied volatility at 110.89 and put implied volatility at 48.78 shown below.
Crude Oil COT Update
WTI Light Sweet Crude Oil (CL) basis March futures declined .05 points or -.1% for the week in a narrow stable trading range.
From a seasonal perspective, this is the time when crude usually starts advancing into the spring buildup. However, since OPEC and NOPEC producers have successfully convinced the market that production will soon decline the spring advance may have already arrived.
The weekly Commitments of Traders reports from the CFTC as of Tuesday January 24, uses the Disaggregated Commitments of Traders – Options and Futures Combined showing activity by “Managed Money,” the group that best correlates with crude oil price changes and arguably the most important.
Last week, “Managed Money” increased longs once again adding another 15,176 contracts while reducing shorts 6,254 for a net change of +21,430, representing 13.06% of the open interest.
Commentary from the analyst community suggests that such a large net long position means a price top is near since large net longs by this group have previously correlated with price tops. Indeed, for the week ending June 10, 2014 the “Managed Money” net long was 15.42% of the open interest when the spot price was at the high of 106.85.
However, it had been in the mid to upper teens many weeks before the price turned lower and since this is January not June, it could remain high for some time.
Over the next few weeks we are going to test the hypothesis that “Managed Money” are trend followers and don?t attempt to pick tops and bottoms, rather they wait to see a trend develop within the “Producer/Merchant/Processor/User,” PMP group and then push the trend until it can go no further. If so, look for the current trend to have trouble when PMP longs decline as PMP Shorts continue higher. Currently both PMP longs and shorts remain near their recent highs.
While this analysis may be simplistic since participants could have interests in more than one group or positions in the “Other Reportables” category or with “Swap Dealers,” but that was also likely true at previous price pivots where “Managed Money” changes best correlated with price changes.
Strategy
As the title indicates, new S&P 500 Index highs are encouraging for the bulls since there is no overhead resistance. However, as the VIX challenges the low made in July 2014 it will return toward the mean on the next pull back. A close below new upward sloping trend line, USTL shown in the chart above will be the first sign to begin considering hedging long positions. In addition to the USTL, and support along with the VIX futures premium, the current Foremost Five in the spotlight all currently supporting the bullish outlook include:
WTI Light Sweet Crude Oil (CL)
iShares Transportation Average (IYT)
ProShares UltraShort 20+ Year Treasury (TBT)
US Dollar Index (DX)
McClellan Ratio Adjusted Summation Index
While it may be a good contrarian strategy to implement hedges when most everything looks positive, the outlook may also remain positive for some time and the combination of our charts and indicators should provide early warning unless interrupted by an unforeseen macro event.
Summary
As the S&P 500 Index made a new breakout high and the VIX challenges the July 2014 low along with other confirming indicators, it looks like the bullish outlook and Smooth Sailing will likely continue for now.