As the S&P 500 Index continues making new closing and intraday highs, signs of increasing volume in VIX options suggests growing hedging activity. This week's Market Review adds details to the regular VIX section along with a call spread suggestion and then a brief U.S. Dollar Index update.

S&P 500 Index (SPX) 4128.80 added 108.93 45.33 points or +2.71% making new closing and/or intraday highs every day. For the past three weeks, the gain totals 5.42%. Now above the top of the parallel channel trend lines from the November lows it appears to have come too far too fast. Should it pullback this week, the previous March 17 high at 3984 looks like a good support area followed by the 50-day Moving Average down at 3914.12.

Invesco QQQ Trust (QQQ) 337.11 gained 12.54 points or +3.86% last week making the three weeks total a whopping 7.61%. Now well above the 50-day Moving Average and back up near the February 16 high at 337.76 risks selling at a double top. As it has for the last three weeks, yield on the 10-Year Treasury Note could determine if it can continue higher or pullback. Last week the yield declined from 1.73% on Monday to end the week at 1.67%. On a pullback the area around the 50-day Moving Average at 321.57 looks like a solid support zone.

CBOE Volatility Index (VIX) 16.69 slid .64 points or -3.89% 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, declined  .71 points or -5.26% ending the week at 12.79 % at another bullish 52- week low. Now well below the mean in the relevant range from June 5, 2020, at 19.70%, regression to the mean at 20.07% should be anticipated. The 52-week chart shows the current low along with the start of the relevant range used to compute the mean at the start of June last year.

VIX Futures Premium 

VIX futures premium on Friday at 15.73% ended in the middle of the green zone, compared to 20.76% on April 1. Front month April futures expire on April 21, with last trading day April 20. Time premium now declining fast.

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. 

CBOE Volatility Index Hedge

With the VIX at 16.69 as shown above and keeping in mind the tendency for volatility measures to regress to their means, along with recent signs of increasing VIX options volume shown in this chart, it seems like a good time to consider a hedge using VIX options.

This 3-month chart shows increasing call implied volatility along with increasing total options volume particularly last Thursday at 1.2 million. Friday's volume at 483K is hard to see up against the right boundary line.

Considerations: One, VIX options are based on VIX futures prices not on the VIX price. Two, both options and futures prices experience time decay at an increasing rate as expiration dates approach. 

With a current Historical Volatility of 112.00 and 120.45 using the Parkinson's range method, the Implied Volatility Index Mean is 95.45 at .08 of the 52-week range. The implied volatility/historical volatility ratio using the range method is .79 so option prices are relatively low relative to the recent movement of the VIX. Friday’s option volume was 482,960 contracts with the 5-day average of 618,780 contracts with reasonable bid/ask spreads.

Looking at Friday's futures term curve May futures were 20.78 while June futures were 22.18. The distance above or below the VIX to the futures, called the premium, shown in the chart above indicates the current relationship of the VIX for the two front-month futures contracts. Since the current front-month April contract will expire in eight days, May will become the new front month. Compared to May options now with 37 days to expiration to June options with 65 days to expiration, June seems like the better choice for a hedge especially since most market indicators remain bullish. Consider it like fire insurance while it's still raining.

If the VIX suddenly spikes higher the entire futures curve will also move higher, but nowhere near the rate of change for the VIX as shown by the downward spikes into negative territory in the futures premium chart above.

Based on Friday's prices with the June futures contract at 22.18, the call spread prices:

Using the ask price for the buy and mid for the sell the call spread debit was 1.05 at 26% of the distance between the strike prices. Since call buyers are bidding up the price of options further out-of- the money, the spread shows a bit of implied volatility edge since the option sold with implied volatility of 98.92 is greater than the option bought at 86.93. In the event VIX opens considerably higher today, adjust the strike prices accordingly. Also, be prepared to roll out the spread to July in 30 days.

Market Breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that considers the number of issues traded, and reported by McClellan Financial Publications, advanced  every day ending the week 132.41 points or +26.43% higher at 633.40. This chart shows it ended the week just below the important 50-day Moving Average at 681.43, but heading higher.

U.S. Dollar Index (DXY) & (DX) 92.16 declined .77 points or -.83% last week after peaking intraday at 93.44 on March 31, very close to the double top measuring objective shown on the chart in Digest Issue 14 "Crude Oil & U.S. Dollar Index [Charts]" last week. Less pressure from rising yield on the 10-Year Treasury Note likely contributed to the decline.

Strategy

In bull markets, a good 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.

From a contrarian perspective, how can you buy low if you don't sell high?

"You can't buy what is popular in do well." – Warren Buffet

Summary

Another week of extraordinary gains by the S&P 500 Index and the Invesco QQQ Trust as interest rates on 10-Year Treasury Note declined along with the U.S. Dollar Index reviving upside momentum for secular growth stocks. Market breadth improved while futures and option indicators remain positive, although with some early signs of VIX hedging activity.