Wrap It Up and Ship Her Away! (IYT,AAPL,DIA,XLP,DBC)

Wrap It Up and Ship Her Away! (IYT,AAPL,DIA,XLP,DBC)

Wrap It Up and Ship Her Away! (IYT,AAPL,DIA,XLP,DBC)

We’re going to open today with an indicator that gets far too much attention, but that still has much to offer if taken in proper perspective.

It’s the VIX Index, the Chicago Board’s measure of implied volatility in S&P 500 options, sometimes called the market’s ‘fear gauge’.

Those with a simplistic view of the VIX claim that when it’s low – watch out! – the market is about to take a spill. These folk see the complacency behind low volatility in options as an inevitable contrarian sign that the market is about to explode.

And there’s truth to the notion that low volatility is eventually replaced by high volatility. The opposite is also true. Periods of high volatility lead directly to periods of low volatility. On a long term chart, it looks like this –

But it’s also clear from the chart that volatility can remain excessively low for extended periods of time, rendering the “VIX at historic lows!” crowd all but irrelevant.

A New Take

We were been pioneers in the formulation and application of a related indicator that we termed ‘volatility compression’. It’s a marker that has served us well through the years as a far more reliable predictor of market selloffs. And we’ll have more to say on that matter in a moment. For a refresher on the concept, please see here.

Before we do, however, have a look at the action in VIX over the last year.

After the market’s January/February selloff, the VIX settled down to a somewhat rocky March and April (in red) that only now is beginning to calm. With ‘price’ now hugging the long term moving averages in the 12.5 to 13.5 level, it appears we’re returning to trend (in blue).

With A Big Caveat!

But before everyone breathes too deeply, we should issue a warning.

The VIX is a derivative data point. It’s taken from a calculation of implied volatilities of a range of 30 day S&P 500 options. In that sense, it’s ‘forward-looking’.

It is not, however, a number that is set by those who invest in it – though, indeed, there exist VIX futures and options that are widely traded. These securities cannot be bid higher or lower by the traders who purchase and sell them. They simply take their cues from the VIX index itself.

To suggest, therefore, that technical analysis can be applied to the VIX is, in our view, mistaken. As a derivative data series, the VIX tells us where we’ve been and the nature of the options market on any given day or week. And in that sense, it is entirely past-oriented. It could only be employed dubiously to suggest where volatility might be a week or month, or even an hour from now.

First, it’s clear that a flat-lining VIX is almost always associated with strongly rising markets. A look at the MACD indicator for most of the last year shows exactly that – a nearly motionless VIX in the midst of perhaps the most accelerated buying spree in equity market history (green box).

A look at individual daily price candles can also be revealing. For example, the amount of ‘compression’ or ‘expansion’ on individual days since New Year’s plays a crucial role in understanding the tenor of the market. In the example above, the VIX compression numbers shrunk by a factor of three between the red-outlined period and the blue.

And that’s significant, because it speaks directly to a massive decrease in the market’s tension level, if you will.

It also explains why we’re now short term bullish on the market’s prospects – very bullish.

And we’ll return to write a related trade after we examine the following three open initiatives.

We’ve been rolling out Apple CALLs for a good bit of time and collecting solid premium on them every go-round. And today we resume the process.

You’ll recall that in our February 15th letter, That’s Some Horse, we rolled the 140 CALL out to May 18th. And seeing as that’s tomorrow, we’re going to buy it back for $46.75 and sell the October 19th 140 CALL for $47.35, giving us another five months and an additional $60 in the pocket.

The Roll Continues

Next up is our October 26th pairing (The Problem With Flying) that recommended you buy the XLP June 15th 53 CALL for $2.33 and sell the DIA June 15th 245 CALL for $2.78. Total credit on the deal was $0.45 per pair.


Today we buy back the DIA CALL – the trade didn’t roll as planned, and we’re left with no choice but to head off the proverbial sasquatch at the donut shop.

DIA option goes for 3.95. Buy it back and wait (pray) for good action from the consumer staples.

Last Up!

Finally, we wrote Stoking the Commodities on April 12th, urging you to buy the DBC October 19th 18 CALL for $0.60 and sell the DBC October 19th 18 PUT for $0.95. Total credit on the trade was $0.35.

Today, after a hefty three month run-up that tacked almost 15% onto the shares, we say it’s time to let go. The CALLs trade for $0.82 and the PUTs for $0.59. Sell the former and buy back the latter and you take home $0.58 on nothing expended. Accounting for minimal commissions gives you a profit of 287% in five weeks!

Bring it on home, Matty!

On an 18 wheeler!

If the market has, indeed, calmed, we’re in for a nice burst higher from here that will likely test former highs. Our read of both the VIX numbers and the Transports, which very regularly lead the market, show a possible break higher as early as today.

Have a look –

This is the Dow Transports for the last six months, and they clearly show an index on the verge of a breakout.

Consider –

  • all moving averages are unfurled and trending higher, and price is above them all,

  • price is at the top end of her four month consolidation, after repeated efforts to break above resistance,
  • RSI is bullishly above waterline and MACD just confirmed by surfacing three trading sessions ago.

It looks strong, folks. Near term, especially.

We’re playing it with the iShares Transportation Average ETF (NYSE:IYT).

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Many happy returns,

Matt McAbby

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