http://www.advicetrade.com/nightlyreport/Pre-Holiday-Rally-Day-20101125466.html Volatility Trading Digest - Bond Market Vigilantes Posted on 11/15/2010 in Trading & Technology by Ivolatility Volatility Trading Digest - Bond Market Vigilantes There were many developments reported by financial media last week, but not much attention was given to the decline in longer maturity Treasury bond prices as the Federal Reserve implemented the first round of quantative easing. Perhaps the bond vigilantes, those responsible for managing large pension and hedge funds, were front running the Federal Reserve purchases and selling long dated bonds. Perhaps it was short-term bond traders fading the Fed purchases. On the other hand, with all the other important activity in the markets last week the answer could be related to the lack of progress made by the G-20 to resolve the trade imbalance and exchange rate issues. ADVERTISEMENT NYSE Best Global Brands Challenge CLICK HERE TO TAKE THE NYSE CHALLENGE Market Review S&P 500 Index (SPX) After a breaking out the previous week, SPX spent last week correcting the breakout. Although Friday's decline could be attributed to fundamental factors, from a technical perspective, it appears to be a normal correction from an overbought condition. Last week we cautioned the SPX has a tendency to overshoot technical objectives and then reverse. That technical objective was the April 26 high at 1219.80 that put in doubt the previous Head & Shoulders Top described in this post. Now we have a potential double top in the works and attention should be on support at 1197.96, the November 3 high just 1.25 points lower. A close below this support level suggests the recent decline is more than a correction of the breakout adding weight to the double top interpretation. E-mini S&P 500 Futures (ESZ0) The support level for the e-mini is the April 3 high of 1198 and Friday?s e-mini close below support raises doubts that the cash will be able to hold its support level. From the open interest numbers, it appears long liquidation began last Tuesday followed by increasing shorting on Wednesday through Friday as the open interest increased. S&P 500 Index Implied Volatility (IVXM) Since our last review two weeks ago, the Implied Volatility Index Mean declined from 19.13 to 18.01, while the VIX declined from 21.20 to 20.61. The table below shows the VIX Cash compared to the next two futures contracts as well as our calculation of the day-weighted average between the first and second months. For this short-term indicator the premium to the cash is a SPX sell signal indicating professional hedging activity and the expectation that the cash will rise back toward the futures price. Last week, the reading was 10.13%, compared to 7.31% in our market review two weeks ago and just before the SPX broke out to the upside. This lower weighted premium level supports the view that the current correction from the breakout high will be limited. VIX Options With a current Historical Volatility of 73.00, the table below shows the adjusted Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon the closing option mid prices on Friday along with their respective months futures prices. The high November implied volatilities, creating an IV/HV ratio of 1.45, indicates option premiums were bid higher on Friday. Higher call premiums suggest hedging strategies. iPath S&P 500 VIX Short-Term Futures ETN (VXX) VXX is an exchange traded note based on VIX Short-Term Futures Index offering exposure to a daily rolling long position in the first and second month of the VIX futures contracts and reflects the implied volatility of the S&P 500 Index one month later. The index futures roll continuously from the first month of the VIX futures contract into the second month of the contract. After a 1:4 split on Nov 9 VXX turned higher after declining as low as 44.00 on the split. Since the VIX futures are usually in contango this ETN will have a downward bias as it rolls from the first month to the second. The current 20-day Historical Volatility is 50.12 up from 43.66 in our last review, while the 30-day Historical Volatility is 47.87 up from down from 43.60 in the last review two weeks ago. The IV/HV ratio is 1.34 creating a positive volatility spread. The Implied Volatility Index Mean is 64.23 with the calls at 65.15 and the puts at 63.32 skewed to the calls. The put-call ratio is .25, normally considered bullish, but in this case bearish for the SPX as call buyers are expecting VXX to rise with a decline in the SPX. US Dollar Index (DX) Although the Fed's QE2 announcement was larger than expected the 76 support held and then it rebounded back to the 77-78 area for a net change of just .19 since our last review two weeks ago. Since there is a seasonal tendency for the dollar to gain strength going into year-end there is good chance it will remain within the 76 -78 range. CurrencyShares Euro Trust (FXE) After breaking out above 140 on the QE2 announcement it declined back to the lower end of the 136-140 range on more debt default news from Ireland. Now that the current bondholders have been assured they will not suffer a haircut it should rally back up to the top of the range once again and should continue supporting equities, commodities and precious metals. iShares Barclays 20+ Year Treasury Bond (TLT) From a high of 109.34 and a yield of 3.46% on August 25, longs bonds have made a substantial move in a short time and are now yielding 4.26%. With QE2 specifically targeted at 1 year to less than 10-year maturities, the decline in long Treasury prices and even Treasuries at the 10-year maturity seems curious. Could it be bond market vigilantes selling positions acquired when there was fear of deflation? If so, that means they believe QE2 will have its desired stimulus effect. Another plausible explanation is bond traders and short-term hedge funds are selling Treasuries and investing the proceeds in "risk on" assets, including equities, commodities and precious metals. Since the Seoul G20 meeting resolved very little relating to the fundamental issues there is no reason to believe the current trends will be reversed anytime soon. NYSE McClellan Summation Index Since our last review, the NYSE Composite Index breadth indicator increased 8.70 points, but is now declining once again. As the NYSE Composite Index and the S&P 500 Index broke out above their April highs, the McClellan Summation Index turned lower creating a noticeable divergence. A further divergence was created when the 9 week Relative Strength Index (RSI) failed to make a new high on the breakout creating a bearish failure swing. Both divergences suggest the current correction is not finished. iShares Dow Jones Transportation Average Index (IYT) As a confirming indicator, IYT also broke out above its April high and up to 89.57 on November 5 before retreating last week. On a weekly chart, with the breakout to the new high, a new three point upward sloping trendline from the March 2009 low was created. It would now take a close back down below 80 to change this uptrend. Perhaps this is more evidence of positive QE2 expectations. Read more: http://www.theoptionsinsider.com/tradingtechnology/?id=5828#ixzz16cSGyOTm The Options Insider: Your Inside Source For Options Information
