Last week's Digest Issue 22 "S&P 500 Index Going Lower [Charts]" got the first part right, there was indeed an oversold bounce. However, by Wednesday the situation changed entirely as it closed above the operative downward sloping trendline. The bulls were having no part of that technical analysis mumbo jumbo indicating it would likely go lower after an oversold bounce. A small updated chart accompanies our regular Market Review followed by iShares iBoxx $ High Yield Corporate Bond ETF (HYG), as an equity alternative, along with VanEck Vectors Rare Earth/Strategic Metals ETF (REMX).

S&P 500 Index (SPX) 2873.34 gained 121.28 points or +4.41% last week, closing above the operative downward sloping trendline, DSTL from the May 1 high at 2954.13 responding to comments on Tuesday from Federal Reserve Chairman Jerome Powell implying an interest rate cut should it be necessary and Mexican officials said they expect to avoid tariffs. The SPX closed up 58.82 points and then followed through on Wednesday adding another 22.88 points, closing above the DSTL marked with an arrow in the chart below. Further advances on Thursday and Friday took it back up to close just below the 50-day Moving Average confirming the change in momentum. Next objective, a test of the May 1 high at 2954.13. It seems as if the bulls stampeded the technical bears.

CBOE Volatility Index® (VIX) 16.30 dropped 2.41 points or -12.88% 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, fell even more dramatically, down 3.67 points or-20.75% ending at 14.02. The IVXM and SPX charts follow.

VIX Futures Premium

The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second-month futures contracts.

With 7 trading days until June expiration, the day-weighted premium between June and July allocated 35% to June and 65% to July for a 4.78% premium vs. -2.30% for the week ending May 31, out of the red zone below zero and into the caution zone between zero and 10. While both the Implied Volatility Index Mean, IVXM and the VIX futures premium improved somewhat they are not as yet confirming the reversal and presumed attempt to retest the May 1 high at 2954.13. A failure to improve this week would raise the caution flag again. The chart below tells the story.

The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration.

For daily updates, follow our end-of-day volume weighted premium version located about half-way down the home page in the Options Data Analysis section on our website.

S&P 500 Index Alternative

For those interested in equity with carry- trade like income, here's an idea.

iShares iBoxx $ High Yield Corporate Bond ETF (HYG) 86.10 up 1.59 points or +1.88% for the week.

When last reviewed in Digest Issue 16 "Foremost Indicators Update [Charts]" it was 86.68 having closed below the upward sloping trendline from the December 26 low at 78.49 and headed lower. Now closing above the downward sloping trendline, DSTL from the May 1 high at 86.47 it appears headed back up to test the May 1 high.

With an average duration of about four years and a positive correlation with the SPDR S&P 500 ETF(SPY) of .87 (see below), it distributes dividends monthly at an annualized rate of 5.33% compared to an annualized quarterly rate of 1.7% for SPY.

With the US 10-Year Treasury Note at 2.09%, the additional risk-adjusted premium of 324 basis points looks favorable compared to a normal range of 200-300 basis points suggested by some bond market pundits.

Along with other broad-based equity indices, the SPY reflects changes in each component in multiple sectors, subject to many influences including earnings, interest rates, commodity prices, sentiment and macro variables such as exchange rates. Into the mix, HYG adds additional information from the bond market such as credit risk and liquidity for M&A, stock buybacks, and refinancing activity making it skewed more toward default risk and liquidity than inflation and interest rates. While useful as a confirming indicator with better dividend yield, additional value comes as a leading indicator from the bond market.

With a current Historical Volatility of 6.21 and 3.82 using the Parkinson's range method, the Implied Volatility Index Mean is 6.67 at .20 of its 52-week range. The implied volatility/historical volatility ratio using the range method is 1.75 so option prices are moderately high relative to the recent movement of the ETF. Friday’s option volume was 341,822 contracts with the 5-day average of 259,580 contracts with reasonable bid/ask spreads. Of the 5.6 million contracts of open interest 4.6 million are puts suggesting considerable hedging activity against long ETF positions, a sign hedge funds and perhaps even big institutions are involved.

Consider this synthetic long or risk reversal idea.

Using the ask price for the buy and mid for the sell the debit would be .42 with good implied volatility edge, meaning the call sold is relatively more expensive in implied volatility terms than the short put. With risk of assignment in the event, HYG closes below 84 at expiration, use a close back below 85.50 as the SU(stop/unwind).

China Trade Rhetoric

With the US and China exchanging increasingly unfriendly barbs, China has been subtly implying they may limit access to so-called "rare earth metals." Although they are not actually rare, processing costs are high and creates heavy pollution so China has become the global leader with six state-owned enterprises (SOEs) dominating the industry.

With all the recent publicity along with increasing uncertainty a trade agreement will be reached anytime soon, it seems like a good an idea to add an options perspective to the narrative since there is an ETF with tradable options available.

VanEck Vectors Rare Earth/Strategic Metals ETF (REMX) 14.78 down .30 points or -1.99% last week.

The good news is there are tradable listed options, the bad news is the volume and open interest is low, making bid/ask spreads wide and with almost all the volume in the July 19 expiration, at or near the money.

After an initial spurt higher on the May 20 and 21 on high volume, it appears to be forming a bullish declining wedge as the consolidation narrows, shown below.

For those with the patience to open and manage low volume option positions here is one call spread idea to consider. First the option details.

With a current Historical Volatility of 39.55 and 27.59 using the Parkinson's range method, the Implied Volatility Index Mean is 45.35 at .52 of its 52-week range down from 62.91 last week. The implied volatility/historical volatility ratio using the range method is 1.64 so option prices are moderately high relative to the recent movement of the ETF. Friday’s option volume was only 1,666 contracts with the 5-day average of 1,400 contracts with wide bid/ask spreads, especially for out-of-the-money strikes. After an initial surge of call volume last month volume it has declined but call option interest remains high at 20,000 contracts compared to total open interest of 22,952 contracts.

Using the ask price for the buy and mid for the sell the debit would be .57 with some implied volatility edge, but it may necessary to pay more as the mid price may not be offered. Even with limited and defined risk, use close back below 14.25 as the SU (stop/unwind).

The risk reversal and spread suggestions above are 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 price change.

Strategy

Last week's reversal improved the picture enough to begin unwinding hedges with the expectation that equities will soon test the previous May 1 high. Then in the event the S&P 500 Index continues even higher the small Head & Shoulders Top described last week in Digest Issue 22 "S&P 500 Index Going Lower [Charts]" will be canceled and a new uptrend will begin.

The apparent agreement to resolve tariffs on imports from Mexico should boost markets this week, although the unresolved China trade issues could still limit upside enthusiasm.

For now, the long side looks much more attractive than it did a week ago as the bulls are back in control again. Oh, one more thing, after 34 days down and only 2 days up, market breadth measured by the McClellan Summation Index turned positive Thursday.

Summary

Last week the oversold counter-trend bounce came as expected and then equities continued higher to close above the operative downward sloping trendline changing the near term outlook from negative to positive. The next likely objective for the S&P 500 Index is a retest of the May 1 high at 2954.13.