Although upward momentum of major indices stalled last week, most of our favorite indicators hardly noticed. Rotation into energy stocks stole spotlight early in the week on news of dramatic crude oil production cuts, especially in the Permian Basin due to extreme harsh weather and power cuts. One report estimated total U.S. production dropped 32%. More details follow the Market Review along with a call risk reversal spread idea for the Energy Select Sector SPDR Fund (XLF).

S&P 500 Index (SPX) 3906.71 slipped 28.12 points or -.71% last week after making a new intraday high at 3950.43 last Tuesday and then closing lower creating another Key Reversal. Wednesday's lower low met the Key Reversal objective. More lower lows and lower highs followed Thursday. Friday it improved slightly making a higher high and higher low than the day before although with a lower close. Should it continue lower expect support around 3850, but it remains well above the uptrend defined by both the upward sloping trendline and the 50-day Moving Average at 3789.00.

iShares Russell 2000 ETF (IWM)  225.19 lost 2.07 points or -.91% last week underperforming SPX Thursday but doing much better Friday with continuing rotation into mid and small capitalized stocks. However, last Thursday tested the upward sloping trendline from the November low suggesting it risks losing the "decider" title unless momentum increases and market breadth improves.

CBOE Volatility Index® (VIX) 22.05 added 2.08 points or +10.42% last week. Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, gained 1.16 points or +7.43% ending the week at 16.78%.

The volatility chart below shows the slight advance back toward what appears as the mean near 20% since May of last year. From this pattern, expect spikes up near 30% on pullbacks followed be declines back toward the mean. However, spikes up above the November high around 32% would begin ringing the warning bell.

VIX Futures Premium 

This indicator declined slightly last week as shown in the weekly chart that adds perspective back to 2019. At 18.33%, a bit lower than last week, but holding in the green bull zone between 10% -20%.

Since most of the volume and open interest are in the two closest futures contracts measuring the volume-weighted premium relative to the standard 30-day VIX provides a good real-time sentiment indicator based upon actual commitments of large Asset Managers and Leveraged Funds. 

Interestingly VIX options volume and open interest both decline dramatically last week. On Friday 2-12 volume exceeded 1.1 million contracts with open interest of 9.6 million, Last Friday volume was only .5 million with open interest of 7.4 million.

Crude Oil

WTI Crude Oil (CL) 59.24 basis March Futures closed the week .23 points lower or -.39%, after reaching an intraday high of 62.26 on Thursday. April Futures become the front Month Monday. While looking overbought, it would need a decline back to 56 to challenge the operative upward sloping trendline from the November 2 low at 35.00.

Backwardation, when near term futures are more expensive than those expiring in future months indicate high near-term demand consistent with seasonal strength that could last until April or May. For example in Digest Issue 4 "Bulls Blowing Bubbles [Charts]" backwardation out to March 22 calculated at 5.80%, on Friday the comparable reading was even higher at 8.42%.

While unusually cold weather reduced production in the short-term the more important considerations include global GDP growth as vaccinations for Covid-19 increase and how much by OPEC + decides to open the production taps. One source says April; others think they prefer targeting yet higher prices. One thing seems clear, diverging opinions among commentators and analysts reflects a comparable divergence among OPEC+ members. In the meanwhile, watch the price since backwardation indicates the cash market looks tight.

Here is an update from the CFTC's Disaggregated Commitments of Traders - Options and Futures Combined report, COT as of last Tuesday February 16.

One way to measure trend momentum is to watch open interest since it needs to keep expanding to sustain price trends both up and down.

This Z score chart standardizes changes in WTI Cash prices and Futures Open Interest putting them on a comparable scale. The updated chart below shows both price and open interest gaining momentum and trending higher.

Accelerating open interest (blue line) confirms the current price advance, especially in the Producer/Merchant/Processor/User (PMP) category, sometime called   "Commercials," confirms the current price advance. 

Based on expectations for continuing price advances consider a call spread risk reversal idea.  

Energy Select Sector SPDR Fund (XLE) 46.18 up 1.51 points or 3.38% last week including 1.67% on Friday as WTI pulled back 2.12%. The weekly chart shows a well-defined double bottom pattern activated with an upside measuring objective at 62.50 back near the April 15, 2019 high at 60. 34.

With a current Historical Volatility of 34.41 and 28.33 using the Parkinson's range method, the Implied Volatility Index Mean is 37.81 at .17 of the 52-week range. The implied volatility/historical volatility ratio using the range method is 1.33 so option prices are moderate relative to the recent movement of the ETF.

Friday’s option volume was 227,734 contracts with the 5-day average of 250,710 with reasonable bid/ask spreads.

Using the ask price for the buy and mid for the sell the call spread debit on Friday was  1.88, less .44 for the put sale making the net debit .74. The short put adds downside risk of assignment in the event XLE closes below 38 at April 16 expiration. Use a close back below well-defined support at 40 as the SU (stop/unwind). 

The spread 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 underlying price change.

Strategy

In bull markets, a best strategy is to stay long equities and/or ETFs and then tactically hedge pullbacks as they begin developing, since ordinary pullbacks can become corrections when something unexpected happens. Then corrections can become downturns when something else unexpected happens, and downturns can become bear markets when many unexpected things change medium and long-term fundamentals.

Last week's Key Reversal and lower closes with slightly weaker market breadth initially prompted thoughts of opening protective put spreads, but after reviewing our indictors unless SPX declines below support at 3850, new downside put spreads seem unnecessary.

Summary

Although the uptrend stalled near the highs last week, our indicators remain positive while the markets continue rotating into cyclicals such as energy along with mid and smaller capitalized stocks. Sizable advances in the crude oil sector suggest a continuation of the uptrend already underway.