Monthly Archives: August 2017

To Take What the VIX Gives You (or Not?)

Things have gotten a little “spooky” in the stock market of late (not everyone is surprised), and the VIX Index – as I wrote about here – has spiked as is typical in these situations. But now what?  I am not good at predictions, so I will not make one.  But how to react depends on what you expect.

The original trade (adjusted to a larger lot size than in the original article) using options on ticker VXX in the article above looked like Figure 1 at the close on 8/17.

1Figure 1 – VXX Nov 12/Oct 14 Directional Calendar Spread (Courtesy www.OptionsAnalysis.com)

Note that there is:

a) An open profit of $1,626 or 73.8%

b) Additional unlimited profit potential (if VXX soared to $21 a share the profit would be roughly $8,000)

c) Maximum risk of -$2,202

So do you feel lucky (punk)?

*If you are playing for a severe market decline (which would almost certainly be accompanied by a sharp rise in VXX) then it might make sense to “let it ride.”

*On the other hand, if you are willing to give up some upside potential to eliminate downside risk, then a simple adjustment might make sense.

For example, a person holding the original position could:

a) Buy back 24 Oct 14 calls

b) Sell 25 Nov 12 calls

The resulting position appears in Figure 2

2Figure 2 – Adjusted position to lock in a profit (Courtesy www.OptionsAnalysis.com)

Note that there is:

a) Additional unlimited profit potential (if VXX soared to $21 a share the profit would be roughly $4,800. Not bad but still significantly less than the original position).

b) The worst case scenario is a profit of $276 (if the position is held until November option expiration AND VXX is at or below $12 a share are that time).

So again, it comes down to a tradeoff depending on one’s expectations:

Summary

If you are playing for “The Big One” on the downside it might make sense to just hold on.  If you are more interested in “ringing the cash register” and letting the rest ride, then an adjustment might make sense.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Keep an Eye on Gold Stocks

Something tells me that gold mining stocks are soon to make a big move.  It kind of makes me wish I had some feel for which direction that move will go.  Of course, the truth is that I have made this case before and was, ahem – at the least – way early.

Still, the situation is what it is.  To wit….

The Current State of GDX

Ticker GDX tracks the NYSE Arca Gold Miners Index.  Of late, it has been “compressing” and “coiling” in a fairly major way.  In Figure 1 we see the narrow range into which price action is contracting.  This is confirmed by the low “average true range” shown in the bottom clip.

1aFigure 1 – GDX “coiling” even tighter(Courtesy AIQ TradingExpert)

Figure 2 displays GDX price action since 2013 and the implied volatility for 90-day options on GDX.  For many securities, extremely low implied volatility often marks the “calm before the storm.”2Figure 2 – GDX implied option volatility at extremely low level (Courtesy www.OptionsAnalysis.com)

Figure 3 displays a weekly chart of GDX with the 14-week ADX indicator in the bottom clip.  Weekly ADX near an all-time low is one more sign of a “quiet” market.  A “quiet market” is typically followed by a “not so quiet market”.3Figure 3 – Weekly ADX indicator at historically low level (Courtesy AIQ TradingExpert)

Adding one more to the mix, Figure 4 shows ticker GDXJ – an ETF that tracks the MVIS Global Junior Gold Miners Index of small mining companies.  The bottom clip displays the daily 14-day ADX indicator.  For those days when the daily ADX indicator is below 12 the bar chart in the top clip is highlighted in green.  Note that these “quiet” periods are typically followed by sharp “bursts” in price action.4Figure 4 – Ticker GDXJ; Weekly ADX readings under 12 often mark inflection points (Courtesy AIQ TradingExpert)

Summary

“Something” – quite possibly something significant – is likely to happen soon with gold stocks.  Now is the time to prepare.

Oh, and if you figure out which direction that move will go – please let me know.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

One More Cry of ‘Wolf’

If I were the type to make bold proclamations I would probably consider “taking my shot” right here and shout “This is the Top” and/or “The Market May Crash.”  Unfortunately, on those occasions (well) in the past when I would make bold public predictions of what was about to happen in the financial markets I would almost invariably end up looking pretty stupid. So even if I did make a “bold proclamation” it wouldn’t necessarily mean that anyone should pay any attention.

Besides all that the last thing I want is for “the party to end”.  Even if you do think the market is about to tank it’s a pretty crummy thing to have to root for.  Even if you did manage to “call the top”, the ripple effect of the ramifications associated with a serious stock market decline can have pretty negative effect on just about everyone’s life.

So let’s put it this way: I am concerned – and prepared to act defensively if necessary – but still have money in the market and am still hoping for the best.

Reasons for Caution (Indexes)

Figure 1 displays four major indexes. The Dow keeps hitting new highs day after day while the others – at the moment – are failing to confirm.  That doesn’t mean that they won’t in the days ahead.  But the longer this trend persists the more negative the potential implications.1Figure 1 – Dow at new highs, small-caps, Nasdaq and S&P 500 not quite (Courtesy AIQ TradingExpert)

Reasons for Caution (Bellwethers)

Figure 2 displays 4 “bellwethers” that I follow which may give some early warning signs.2Figure 2 – Market Bellwethers possibly flashing some warning signs (Courtesy AIQ TradingExpert)

*SMH soared to a high in early June and has been floundering a bit since.

*Dow Transports tried to break out to the upside in July but failed miserably.

*XIV is comfortably in new high territory.

*BID tried to break out in July and then collapsed.  It is presently about 12% off of its high.

In a nutshell – 3 of the 4 are presently flashing warning signs.

Reasons for Caution (Market Churn)

In this article I wrote about an indicator that I follow that can be useful in identify market “churn” – which can often be a precursor to market declines.  Spikes above 100 by the blue line often signify impending market trouble

It should be noted that the indicators signals are often early and occasionally flat out wrong.  Still, a churning market with the Dow making new highs has often served as a “classic” warning sign.

3Figure 3 – JK HiLo Index (blue) versus Nasdaq Compsite / 20 (red); 12/31/2006-present

Summary

Again, and for the record, I do not possess the ability to “predict” the markets.  But I have seen a few “warning signs” flash bright red at times in the past.  As a general rule, it is best to at least pay attention – and maybe make a few “contingency plans” – you know,  just in case.

For more variations on the theme be sure to review:

Respect the Trend, But Beware

On Picking a Bottom in VXX

Here’s hoping my gut is wrong – again.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Taking What The AAPL Gives You

This is a lesson in subjective analysis.  Not a lesson so much maybe as an example.  Because subjective analysis is just that – making decisions on the fly based on “gut”, “instinct”, and/or accumulated experience.

The AAPL Story

In this article I wrote about a hypothetical trade using options on AAPL anticipating a bounce back up towards a previous high.

In this article I raised the idea of potentially “doing something” to lock in a profit.

Now in this article I am going to say that on a subjective basis I would take a profit and close the trade here.

The current status of the example trade appears in Figure 1.1aFigure 1 – AAPL Calendar Spread as of 8/2/17 (Courtesy www.OptionsAnalysis.com)

Note the following:

*AAPL has bounced back up to its previous high – which was the impetus of the trade in the first place.

*The trade now has an open profit of 149%

*I have no idea where AAPL is headed next

*Also, while AAPL is sharply higher on the day, many of the other FAANG stocks are heading in the opposite direction at the same time.2a

Figure 2 – AMZN stock (Courtesy: Barchart.com)

3a

Figure 3 – NVDA stock (Courtesy: Barchart.com)

4a

Figure 4 – PCLN stock (Courtesy: Barchart.com)

With our trade objective (i.e., AAPL retouching the old high) reached, with a sizeable % profit and with the other stocks in the “club” acting in an exactly opposite manner, I for one would probably “ring the cash register” at this point.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

On Picking a Bottom in VXX

The VIX Index is an index calculated by the Chicao Board Options Exchange (CBOE) and designed to measure volatility in the stock market and is presently near its all-time low. Some argue that it has “nowhere to go but up.”  Like the “boy who cried wolf” some analysts have been making this argument for quite some time – to no avail, at least so far.

Ticker VXX is an Exchange-Trade Fund that is designed to track the VIX Index.  Therefore, the idea of “picking a bottom in VXX” means betting on greater volatility in the stock market.

OK, before we go any further, it is important to look at Figure 1 and recognize the huge potential folly represented by the title of this article.1Figure 1 – Ticker VXX consistently trends lower with occasional spikes (Courtesy AIQ TradingExpert)

Anybody who attempts to play the long side of ticker VXX is plain and simply bucking some long odds.  Understand that it wasn’t supposed to be this way.  Originally the ETF ticker VXX was intended to track the VIX Index.  That didn’t come anywhere close to happening as you can see in Figure 2.2Figure 2 – VIX Index versus Ticker VXX (Courtesy AIQ TradingExpert)

This, ahem, slight difference in performance is because of something called “contango” (which involves the differences in price between futures contracts of various  months and I am not gonna lie, is kind of a boring technical topic – which is why I am going to let you Google it if you so desire rather than go into a boring technical explanation).

The bottom line: Ticker VXX has trended sharply lower since inception – with an occasional sharp spike higher.

The questions at hand are:

a) Is one of those sharp spikes higher at hand?

b) Given the long term trend for VXX, is it even worth betting on a spike higher?

(See also Respect the Trend, But Beware)

Seasonal Trends in Volatility

The VXO Index is similar to the VIX Index.  The VXO Index is calculated using options on the S&P 100 Index while VIX is calculated using options on the S&P 500 index.  While they are two different indexes and will trade at different price levels, their movements are roughly 95% correlated to each other.

I bring up ticker VXO and its close correlation to VIX because: Figure 3 is courtesy of Larry McMillan of The Option Strategist and displays the “average” day to day movement of the VXO Index across an “average” year.  Note the strong tendency for VXO to rise from July into October.  Because VXO and VIX are so highly correlated we can expect similar action in the VIX Index – i.e., a tendency to rise from July to October.3Figure 3 – Annual Seasonal Trend for VXO – i.e., volatility often spikes August into October (Courtesy: Options Strategist)

So with the VIX Index presently at an extremely low level and with a strong tendency for volatility to rise between July and October can we count on a spike in volatility in the months ahead?  Not necessarily.  But if we one were going to “buck the long odds” and attempt to play the long side of volatility ETFs, it might soon be time to take a look.

One Way to Play

As with most opportunities there are a lot of ways to play.  The simplest approach of course would be to buy shares of ticker VXX.  However, not only is overall volatility in the market low – as indicated by the low readings in the VIX Index itself – but the implied volatility for the options on VXX itself is also near the low end of its historical range as you can see in Figure 4.4Figure 4 – Price chart for Ticker VXX with implied option volatility for VXX options (blue line); Implied volatility (blue line) for options on VXX is relatively low (Courtesy www.OptionsAnalysis.com)

So for the purposes of “crafting” a trade that can potentially profit if volatility rises in the months ahead we will assume that:

a) Overall volatility will rise (i.e., VXX will trade higher)

b) Implied option volatility on VXX options will also rise

So we want a position that can profit from a higher price for VXX and/or a rise in implied volatility.  One strategy that fits this category is a “calendar spread.”  The position displayed in Figure 5 and 6 involves:

*Buying 5 VXX Nov 12 calls at 1.31

*Selling 4 VXX Oct 14 calls at 0.72

5Figure 5 – VXX Calendar Spread (Courtesy www.OptionsAnalysis.com)

6Figure 6 – VXX Calendar Spread Risk Curves (Courtesy www.OptionsAnalysis.com)

Things to note:

*The initial cost and maximum risk $367 for a 5×4 position

*If VXX is unchanged by October option expiration the loss would likely be less than $200.

*If VXX continues to trend lower this trade will lose money, so this is a speculative play on an upside reversal in VXX

*If VXX does rise then time decay will work in favor of this trade.  In other words, as time goes by the October options will experience relatively more time decay than the November options.  See Figure 6 to see the potential positive effect of the passage of time.

*In addition, because this trade is long one additional November call option there is unlimited upside  profit potential if a “crazy spike” – ala 2008 were to unfold.

Finally, if we are correct and an increase in implied volatility accompanies a rally in VXX, the profit should grow even more.

In Figure 5 note that:

*The November 12 call has a “Vega” of 2.4 and the October 14 has a “Vega” of minus 1.9.

*This means that for every one percentage point increase in volatility then November 12 call will gain an additional $240 and the October 14 will lose -$190 (due solely to changes in volatility).

If IV levels spike say 30% higher from current levels, the overall trade profit can increase substantially on a percentage basis.  See Figure 7.7Figure 7 – A rise in implied option volatility pushes risk curves to the right (i.e., higher) (Courtesy www.OptionsAnalysis.com)

(See also Live by the FAANG, Die by the FAANG)

Summary

Let’s be brutally candid about two things:

1) People have been declaring for months that volatility in the market is “too low” and that a rise is “overdue.”   And all the while the VIX Index just keeps creeping lower.  There is no reason this can’t continue.  And even if it doesn’t continue….

2) Ticker VXX has a serious, persistent downward bias to it – which should give a trader serious pause before entering into a bullish trade on VXX.

With those two points firmly in mind:

1) Figure 3 suggests that if volatility is ever going to pick up again the next several months are as likely as time as any for it to happen.

2) The example trade in Figures 4 through 7 (which is just that – an example” and not a “recommendation”) can take advantage of a rise in volatility that plays out over a couple of months time.

Of course, a sharp rise in stock market volatility is typically a companion of declining stock prices.  So as always – be careful what you wish for…..

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

When Dividends Shine

It really doesn’t require rocket science to do alright in the markets.  Now Lord knows it’s pretty easy to get wrapped up in “crunching numbers” (“Hi, my name is Jay”), but sometimes simple strategies can do reasonably well. Every once in a great while us “quantitative types” stop doing calculations long enough to look up and look around at “slightly less complex” methods.

Good thing too.

Consider the following strategy based on the S&P Dividend Aristocrats Index. This index focuses exclusively on companies in the S&P 500 that have grown dividends for at least 25 consecutive years.  The ETF ticker NOBL (ProShares S&P 500® Dividend Aristocrats ETF) tracks this index.

(See also Respect the Trend, But Beware)

Here is the “Non Rocket Science Related Dividend Strategy”:

*Hold the S&P Dividends Aristocrats Index during March, April, May, November and December.

*Hold Cash during all other months (for purposes of this test we will assume annual rate of interest of 1%)

Using monthly total return index data from the PEP Database by Callan Associates, the results appear in Figure 1.1Figure 1 – Growth of $1,000 using Jay’s Non-Rocket Science Related Dividend Strategy; 12/31/1989-6/30/2017

For the record:

*Average 12 months = +10.5%

*Median 12 months = +9.1%

*Standard Deviation of 12-month returns = 7.5%

*Worst 12 months = (-3.5%)

*Maximum Drawdown = (-6.6%)

(See also A Focus on the Trends in Stocks, Bonds and Gold)

Summary

Is this a “world beater, you can’t lose in the stock market” strategy?  Not at all (especially since there is no such thing).  But it does offer a place to start looking for someone looking for a relatively low volatility investment strategy.

Now if you will excuse me I have to get back to dividing the 3-day RSI by its own 10-day moving average.  I think I may be onto something.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.