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

Although the S&P 500 Index continues nudging higher the cyclicals now referred to as the “Trump” or “Risk On” stocks and ETFs are losing steam and starting to rollover being replaced by their “Risk Off” counterparts. There is more below along with a Commitments of Traders crude oil update and a trade idea to consider for Utilities Select Sector SPDR ETF (XLU).

Review Notes

S&P 500 Index (SPX) was up another 16.18 points or .69% for the week after advancing above 2350 last Tuesday, creating another new support (S1). The upward sloping trend line, USTL from the November 4 low now crosses at 2325 and is one of the key levels to watch in the event of a pullback. Then there is also support at 2300 (S2) and whole lot of support at 2275 (S3) going all the way back to December 13.

CBOE Volatility Index® (VIX) declined .02 or -.2% for the week. The comparable IVolatility implied volatility index mean, IVXM advanced from 8.64 to 8.78 +.14 or +1.62 %.

VIX Futures Premium

The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second months.

With 17 trading days until the March expiration, the day- weighted premium between March and April allocated 68% to March and 32% to April for a 21.57% premium Friday. However, since the VIX was almost unchanged for the week the premium advance was due to higher futures prices Thursday most noticeable in the deferred months suggesting increased hedging activity.

Crude Oil & Commitments of Traders Update

WTI Light Sweet Crude Oil (CL) basis April futures advanced .21 or +.39% last week continuing to trade in a narrow range between 52 and 54. From a seasonal perspective, this is the time when crude prices usually start advancing into the spring buildup. Indeed last year they turned higher in the second week of February. However, since OPEC and NOPEC producers may have successfully convinced the market that production will soon decline the spring advance may have already arrived.

The narrowing contango further supports the bullish view from June 2017 to June 2018 prices turned slightly into backwardation -.13 or -.24%, even more for December 2017 to December 2018 at -.92 or -1.08%.

However, weakness in the stock prices of the oil service and exploration & production companies seems to reflect diminished expectations for any further advance creating a noticeable divergence with the price of crude.

The weekly Commitments of Traders reports from the CFTC as of Tuesday February 21 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 their long position by another 20,086 contracts and decreased shorts +3,213 for a net change of +23,299 to 413,637 contracts representing 15.16% of the open interest, the highest since June 17, 2014 when it was 15.64 % and crude was 106.82.

We continue testing 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 with the “Producer/Merchant/Processor/User,” PMP group and then push the trend until it can go no further. If so, the current trend may have trouble when PMP longs decline as PMP Shorts continue higher. This week PMP longs declined -65,686 but so did the shorts +53,290 for net -12, 347.

Here is the “Managed Money” position from June 10, 2014 when WTI cash crude was 106.85. Their increasing long position is consistent with the seasonal tendency and declining contango, but inconsistent with declining stock prices of the oil service and exploration & production companies.

For comparison here is a chart for the PMP Net Shorts as a percentage of the open interest showing signs of turning higher.

Since the March futures contract expired Tuesday and the open interest declined significantly as it normally does on Monthly contract expirations, perhaps it may be premature to suggest that PMP will continue increasing their shorts and “Managed Money” will follow. Next week’s report should have the answer, but if “Managed Money” does begin selling, expect prices to decline this week.


Despite the overall market remaining bullish there are signs of increasing hedging activity such as higher VIX futures, higher equity only put/call ratio, lower VIX put call ratio and a wide divergence between the VIX call and put implied volatility. There are also signs that our old friends the Algo Rotators are back as the cyclicals and financials recently labeled “Trump” stocks are getting whacked as money moves into the defensive secular growth stocks such as health care, consumer staples and utilities referred to as the “Risk Off” group along with Treasury bonds.

The US Dollar Index (DX) & (DXY) is the other important contributor to this rotation scenario and while it was up .14 for the week it looks like an H&S Top could be underway. Remember about 75% of US equity market variance is explained by macro variables, such as exchange rates, interest rate differentials and bond prices.

“Risk Off” Rotation

After comparing, the implied volatilities, option volume, bid/ask spreads as well as implied volatility/historical volatility ratios of XLP, XLV and XLU this one has the best liquidity although call spreads for them all should work assuming the “Risk Off” trade continues despite recent comments from the Federal Reserve that interest rates will soon rise.

Utilities Select Sector SPDR ETF (XLU) 51.59 advanced 2.02 points or +4.08% for the week rising at an unsustainably rapid rate. Selecting a June call spread should allow enough time for a pull back before continuing higher.

The current Historical Volatility is 11.86 and 9.96 using the Parkinson’s range method, with an Implied Volatility Index Mean of 14.09 down from 14.39 the week before. The 52-week high was 22.27 November 14, 2016 while the low was 12.34 on January 27, 2017. The implied volatility/historical volatility ratio using the range method is 1.41 so option prices are reasonable relative to the recent movement of the ETF. Friday’s option volume was 120,045 contracts with a 5-day average of 46,800 contracts with reasonable .01-.03 bid/ask spreads.

Consider this June call spread idea.

Using the ask price for the buy and mid for the sell, the call spread debit would be .70 about 35% of the distance between the strike prices with 46% of the long call risk hedged by the short call. Use a close below support at 49.50, the February 21 breakout level, as the SU (sell/unwind).

The spread suggestion above is based on the ask price for the buy and middle price for the sell presuming some price improvement is possible. Monday’s option prices will be somewhat different due to the time decay over the weekend and any price change.


While the S&P 500 Index remains above the current upward sloping trend line and in bullish territory despite rotation out of cyclicals into secular growth issues and Treasury bonds, there are increasing signs of hedging activity suggesting tactical traders and portfolio managers are becoming more cautious.