Volatility Trading Digest: Trend or Rotation?
Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Any further advance by the S&P 500 Index may be limited without the help of accelerating earnings, while evidence of sector rotation into "Risk Off" groups suggests increasing caution. Sector rotation means paying less attention to the fundamentals while attempting to identify short-term tops and bottoms and remembering the real money comes when aboard a trend. There is more after a brief market update including a comment on the latest crude oil Commitments of Traders report along with a trade suggestion for iShares MSCI EAFE (EFA).
S&P 500 Index (SPX) gained another 15.78 points or .67% for the week after gapping higher Wednesday to test 2400 before retreating Thursday and Friday. The gap above 2370 could be filled as it tests this newest support adding to the ones at 2350, 2300 and 2275 going all the way back to December 13. The upward sloping trendline, USTL from the November 4 low now crosses just above 2325 and is the key level to watch should 2370 and 2350 fail in the event of a pullback.
CBOE Volatility Index® (VIX) declined .51 or -.4.45% for the week while the comparable IVolatility implied volatility index mean, IVXM now 8.57 declined .21 or -2.39%. As a measure of the current bullish market condition, both are back near their 52-week lows.
VIX Futures Premium
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 March expiration, the day- weighted premium between March and April allocated 48% to March and 52% to April for a 23.36% premium as the VIX declined more than the futures last week.
Crude Oil COT Update
WTI Light Sweet Crude Oil (CL) 53.33 basis April futures declined .66 points or -1.22% for the week while continuing to trade in a narrow range between 52 and 54. From a seasonal perspective, this is the time when crude usually starts advancing into the spring buildup. Last week we discussed details of the relationship between the changes made by "Managed Money" and the Producer/Merchant/Processor/User, "PMP" group from the weekly Commitments of Traders report concluding chances were increasing for "Managed Money" to begin reducing their unusually long net position.
Indeed the Disaggregated Commitments of Traders - Options and Futures Combined report as of February 28, shows "Managed Money" decreased their long position by -17,555 contracts last week and increased shorts -9,375 for a net change of -26,930 contracts representing 13.99% of the open interest, down from 15.16% the previous week. However, slight increases by "PMP" along with greater increases by "Other Reportables," Swaps, and "Non Reportables" offset "Managed Money" selling, leaving the price almost unchanged for the week.
Although "Trump" stocks advanced Wednesday after Trump’s speech to Congress, by the end of the week many retreated leaving the sector rotation mixed and complicated by what appears to be selling on the news after Yellen greatly increased the probability of an interest rate increase at the upcoming March 14-15 FOMC meeting. Most noticeable the US Dollar Index (DX) & (DXY) 101.34 declined .86 for the day renewing the possibility that an H&S Top could be underway.
While awaiting confirmation that rotation into "Risk Off" sectors remains on track perhaps adding some up trenders could be beneficial.
Accordingly, like in Digest Issue 8 "The Trend is your Friend [Charts]" we again fired up our Stock Sentiment Ranker. This time for the Stock list, we used a new ETF group created in My Favorites to identify the top twenty set to scan for stock prices greater than 5 with market capitalizations greater than 1 billion with options volume greater than 2000. The other settings were any volatility, high Call/Put ratio, and high exponential moving average EMA, relative strength RSI and with positive Chaikin Money Flow, CMF. Here are the top 20 ETFs.
Among those with the highest Bullish rank are several in global markets seemingly adding confirmation that economic conditions overseas are improving and thus removing one of the obstacles cited by some Fed Governors that precluded earlier interest rate hikes.
In fact, the chart of number 2, EFA confirms a well-defined uptrend from the December 28 low.
iShares MSCI EAFE (EFA) up .49 or .81% for the week, this ETF tracks the equity performance of 21 countries in Europe, Australasia, and the Far East.
The current Historical Volatility is 7.17 and 4.66 using the Parkinson's range method, with an Implied Volatility Index Mean of 9.69 up from 9.46 the week before. The 52-week high was 29.70 on June 27, 2016 while the low was 9.02 on February 21, 2017. The implied volatility/historical volatility ratio using the range method is 2.08 so option prices are expensive relative to the recent movement of the ETF. Here are the volatility and price charts.
While the current implied volatility is near the 52-week low, the chart suggests a return to the mean value around 15.
Friday’s option volume was 105,101 contracts with a 5-day average of 80,850 contracts with reasonable bid/ask spreads.
Consider this June ratio call, or backspread, long more options than short expecting increasing volatility.
For the June 64 calls the prices above are for each option so the total would be 1.24 for two at the ask price. Using the mid price for the June 62 sale of 1.39 the net credit would be .15
Use a close below the upward sloping trendline now about 60.50 as the SU (sell/unwind).
While other ratios such as 2 x 3 will achieve similar results, the concept is to have more long options than short.
The backspread 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.
Although the major US indexes continue making new highs, global equities including emerging markets have started trending higher as well. While accepting the risk that increasing allocations to global equities may be just another short-term rotation that will soon reverse they may also continue trending higher presuming recent favorable economic data continues. While the current global outlook looks positive, remember adding some hedges will provide worthwhile protection against unforeseen macro or political events.
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