Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.

As the DJ Transportation Index turned higher last Wednesday it looks like we were on the right track last week. The decline was just another round of sector rotation with high frequency traders, called “Algo Rotators” doing the whacking and not the result of deteriorating fundamentals. The review has more including an iShares Transportation Average (IYT) chart and a trade idea for American Airlines Group Inc. (AAL) followed by a WTI crude oil update from the Commitment of Traders perspective.

Review Notes

S&P 500 Index (SPX) up 4.53 points or +.18% for the week all on Friday. Although most indicators remain bullish August is seasonally one of the weakest months of the year so a test of the upward sloping trendline, USTL near support at 2450 and the 50-day moving average near 2440, seems likely.

Transportation

iShares Transportation Average (IYT) made an important pivot last Wednesday before testing support at the upward sloping trendline, USTL and then continuing higher advancing .99 points or .60% for the week including 1.27 points Friday. According to Dow Theory the lagging transports have been sending a negative divergence warning as the DJ Industrial Average made new highs. Now, turning higher at an important crossroad, it seems the recent pull back was simply another bout of profit taking rotation by our “Algo Rotator” friends. Any further advance will confirm that bulls can continue charging even though it may be premature to declare selling in the sector ended entirely, the outlook is much brighter as the divergence begins fading away like a passing shadow.

Here is the updated chart for this important sector showing the important pivot.

The Stocastic indicator turned positive after being below 20, usually a good buying signal.

Although August is seasonally weak for the S&P 500 Index there could be still be sector rotation opportunitines and since IYT options volume is low here is an alternative idea with good options volume and reaonalbe bid/ask spreads.

Review Notes

American Airlines Group Inc. (AAL) up .31 points or +.61% for the week after finding support at the upward sloping trendline, USTL and then quickly recovering making a wide trading range to close back above the 50-day moving average after declining from a July 13 intraday high of 53.81.

First the option data then the chart.

The current Historical Volatility of 21.41 and 21.81 using the Parkinson’s range method, with an Implied Volatility Index Mean of 26.33 near the 52-week low of 25.97. The implied volatility /historical volatility ratio using the range method is 1.21, so option prices are relatively inexpensive compared to the recent movement of the stock with a low options implied volatility index.

Having just made a Stochastic buy signal below 20 it appears headed higher.

Friday’s option volume was 20,000 contracts traded compared to the 5-day average volume of 19,640.

Since the strike prices are 5 points wide using a September bull call spread is unattractive due to the lower implied volatility of the out-of-the-money call so better to just buy the option with lower implied volatility. Consider this long call idea.

Use a close below the upward sloping trendline, USTL about 49.50 as the SU (stop/unwind).

The suggestion above is based on the ask price. Monday’s option prices will be somewhat different due to the time decay over the weekend and any stock price change.

Crude Oil Update

WTI Light Sweet Crude Oil (CL) basis September futures down .13 points or +.26% for the week, after exceeding resistance at the downward sloping trendline, DSTL considerably above the 50-day moving average (red line below).

From the Disaggregated Commitments of Traders – Options and Futures Combined report as of August 1 “Managed Money,” the group that best correlates with crude oil price changes and arguably the most important, added substantially to their long position +42,483 contracts and reduced their shorts +1,378 for a net position increase of +43,861 contracts representing 9.50 % open interest up from 8.40% the week of July 25 and up from 4.73 % on June 27, the last pivot shown here.

“Managed Money” buying was offset by Swap Dealer, or “Swaps” selling again and now their net short position greatly exceeds the net long position of “Managed Money.” As a percentage of the open interest “Swaps” were 11.25% net short vs. 9.50% net long for “Managed Money.” Here’s a look at the “Swaps” chart.

Shown by change in numbers of contracts.

Producer/Merchant/Processor/User, (Commercials ) or “PMP” +2,459

Swap Dealers, or “Swaps” -63,079

Money Manager, or “Managed Money” +43,861

Other Reportables, or “Others” +18,361

Others +485

Non Reportables (Small Traders) -1,603

The Commodities Futures Trading Commission defines “Swap Dealers” as:

“A “swap dealer” is an entity that deals primarily in swaps for a commodity and uses the futures markets to manage or hedge the risk associated with those swaps transactions. The swap dealer’s counterparties may be speculative traders, like hedge funds, or traditional commercial clients that are managing risk arising from their dealings in the physical commodity.”

“Swaps” selling into “Managed Money” buying complicates the analysis since they could represent “speculative traders, like hedge funds, or traditional commercial clients that are managing risk arising from their dealings in the physical commodity.” However, their selling seems to suggest a lack of conviction that the current advance can continue although seasonally August is usually better than July.

 

Summary

The negative divergence between the S&P 500 Index and the DJ Transportation Index, that was previously the one negative indicator causing some concern appears to have moderated last week thereby improving the bullish outlook. Should it continue higher, as seems likely, delighting the bulls although August is seasonally one of the weaker months.