Posts Tagged ‘Index Options’

April 24, 2011

Another week is behind us.  The markets continued their march upward.  Here is the summary:

As you can see above, the major indices are all up for the week and options’ month. However, the VIX, the SPX volatility index is DOWN 40% since April 15, 2011, the end of the last options’ month.  This is something worth looking at since it may signal an upcoming market top and danger of a reversal. Take a look at the 5 year VIX chart:

As you can see in the chart, the VIX is at it’s lowest in over 3 years. Although it was lower than that in 2006 and part of 2007 (left 2 columns) this was BEFORE the mortgage and market fiascos.  Here is what the SPX looks like for the past 5 years, which generally is going the opposite of the VIX:

The red line, which is about 1345 – 1350 is the first obstacle the SPX will have to overcome to move higher. It was almost there twice in 2011 but in both cases it turned around. IF it penetrates that line (the red one) the next one will be the blue line, around the 1440 – 1450 mark. By the way, notice that both lines represent previous tops for the SPX.  Should the SPX get that far the VIX most likely will drop to the 2006-2007 lows.

For us, options’ and stock traders it is significant since low volatility (VIX) means low options’ premiums.  It is cheaper to just buy the options (low premiums) but as statistics show, most straight options’ buyers lose money. For those who do spreads, covered calls and occasionally naked puts, the lower premiums on SELLING the options makes it more difficult to trade on a shorter term, balancing the net lower premiums and the risk.

Let’s see what happens next week. I am very cautious at this point and keeping a close eye on both the SPX and VIX. By the way, it may represent an opportunity for us to open a position on both, taking into account that USUALLY both move in opposite directions.

Cheers

Erik

April 21, 2011

The stock market keeps marching on. Below are 3 charts: the 1 year S&P 500 (SPX), CBOE SPX volatility Index (VIX) and VXX which is the VIX short term ETF.

As you can see in the above charts, normally  as the SPX rises the VIX, and therefore the VXX fall.

The VIX is at it’s lowest in more than 3 years (see 5 year chart below) and the VXX, being newer, is at its lowest ever.

Note what happened when the VIX went that low: It started to rise, meaning the SPX started to fall, and eventually exploded to the upside. It will happen again. When? I cannot tell you that but I can tell you that the danger level is now quite high.

For us options’ traders drastic declining VIX (volatility) means much lower premiums on options we try to sell, such as spreads, naked puts/calls and covered calls. Of course it makes it cheaper to BUY the options. However, with buying options we may be right eventually, but if we are not exactly right on the timing, no matter how cheap the options are (were), they will go down in value and eventually expire worthless.

Happy Easter everyone.

Erik Epp

The market popped up this week on “better” than expected revenues from several companies.  Of course if the “expectations” are low to begin with (the analysts and the companies do not want to “disappoint”), surpassing them is not a big task.  Add to it that much of the “increase in revenues” came from cost cutting (such as letting people go) and accounting (such as one time items) and the picture MAY not be as rosy as it might appear.

Here is what the SPY chart looks like this week, rising 38 points or 3.6% (as per comments last week, we are using last week’s closing price as the basis for the percentage).  Below is the WEEKLY chart since the beginning of 2010.

On a weekly basis (Friday to Friday closings) the next hurdle for the SPY to overcome on the upside is 112 which occurred on June 18, 2010 (options expiration day). On a daily basis, May 17th close @ 114 is the number to beat.

The market, as measured by the S&P 500 (SPX), the most widely used index for stock/ETF and portfolio performance has been going up, for the most part for the past year (as measured from today).

The problem however with the SPX is that it is weighted in favor of the biggies.  The top 20 companies (out of 500) take 30% over the total weight of the index (must add up to 100%).  The top 48 take 50% of the total weight, which means 450 companies share in the rest.  So is the market advance  simply the result of few biggies pushing the SPX up, or is the majority of the 500 companies participate in the party?

In order to find out we need a chart of the SPX that is equally weighted; each company gets the same percentage weighting or 0.2% per each company (100 / 500).  Fortunately, there is such a chart; the symbol is SPXEW.  Below is a chart comparing both, the SPX and the SPXEW.  As you can clearly see, the market is not just being driven by the biggies but actually is mostly driven by the “less biggies’.  Keep in mind that we are still talking about the 500 companies in the S&P 500.  The Nasdaq 100 (top 100 companies on the Nasdaq) is displaying similar pattern as the S&p 500, telling as the broad market is participating in the rise.