Strategy
In this issue, we update our indicators and then explain why we remain cautious while offering two work in progress ideas, one an updated hedge using iShares Russell 2000 Index (IWM) and another long SPDR Gold Shares (GLD) suggestion.
Three weeks ago we highlighted the S&P 500 Index (SPX) close below the important 1400 support level setting off the Head & Shoulders Top with the minimum downside-measuring objective at 1327. On November 16, it reached 1343.35 before making a key reversal and then closing back above the 1400 resistance on Friday. There are several reasons for thinking it will soon retest the 1343.35 low including the low volume advance this week, and more importantly, it most always retests important lows. In the last year, there have been seven other meaningful declines – all retested within a few weeks. If this advance, which has occurred on low volume continues without retesting it will be the exception. Therefore, from a technical perspective the odds favor a retest with the Head & Shoulders Top measuring objective down at 1327 still possible.
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Conditional Hedge Update
iShares Russell 2000 Index (IWM)
Last week’s advance from the key reversal was straight up so we did not have a chance to open the hedge suggestion in Digest Issue 46. Now with a close above 80 all we need to see is a lower high and a lower low or some other indication that the current advance it stalling. We are expecting a retest of the November 16 low, but be aware it could be over quickly. If so, we will begin unwinding all of our open hedge positions.
The updated option details omitted from last week’s suggestion follow.
The current Historical Volatility is 16.46 and 13.07 using the Parkinson’s range method, with an Implied Volatility Index Mean of 17.13 down from 19.19 last week. The IV/HV ratio is 1.04 and 1.31 using the range method to calculate the HV. Friday’s put-call ratio was bearish at 2.00, but understandable since it is a hedging favorite. The volume was 287,753 contracts traded compared to the 5-day average volume of 303,340.
The strike prices and premiums may need adjusting once again when implemented, but here is the suggestion using Friday closing prices.
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At 22% of the distance between the strike prices, this spread has a good risk to reward ratio and a reasonable volatility edge. If implemented, use a close back above 82 as the SU (stop/unwind).
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More Seasonal Gold
As we mentioned in two weeks ago, chances are all of the chatter about the fiscal cliff over the next couple of weeks should help to support gold, so here is another suggestion to consider.
SPDR Gold Shares (GLD)
Here are the relevant option numbers.? The current Historical Volatility is 12.76 and 8.13 using the Parkinson’s range method, with an Implied Volatility Index Mean of 12.22, down from 12.36 last week. The IV/HV ratio is .96 and 1.50 using the range method to calculate the HV. Friday’s put-call ratio at .62 was just under the bearish line, while the volume was 116,314 contracts traded compared to the 5-day average volume of 125,200 contracts for the low volume short holiday week.
Consider this long call add on spread suggestion.
At 36% of the distance between the strike prices, it has a an attractive risk to reward ratio. Continue using a close back below the last pivot made on November 2 at 162.30 as the SU (stop/unwind).
Both the suggestions above use the closing middle price between the Friday bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
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Summary
Encouraging as it was for the bulls the bounce off the recent key reversal is likely to encounter selling as the volume increases back toward more normal levels after Thanksgiving week. The odds favor a retest of the November 16 low and it could start in the next few days. Once completed we could see an advance lasting into year end.