Stock Market: Trading Idea Generator
Last week both the S&P 500 Index and the Invesco QQQ Trust pulled back to test support at their respective 50-day Moving Averages while futures and options indicators suggest some of the downward pressure may have been alleviated. The Market Review includes details followed by a look at Friday's Top 5 for trade ideas while waiting to see if the two major averages will hold important support levels.
S&P 500 Index (SPX) 3340.97 declined another 85.99 points or -2.51% last week just slightly more than the week before when it declined 81.05 points or -2.31%. Friday's intraday low of 3310.47 exceeded the 50-day Moving Average at 3321.56, but then closed back above this closely watched target. Since support is more like a zone than a specific number the answer should come this week.
Invesco QQQ Trust (QQQ), 270.45, called "the decider," slid 13.13 points or -4.63% last week closing just below and the 50-day Moving Average down at 271.38. Will "buy the dippers" prevail and turn "the decider" higher, or will sellers push the big cap tech favorites s even lower? Stay tuned.
CBOE Volatility Index® (VIX) 26.87 drifted back down toward the end of the week declining 3.88 points or -12.62%. 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, slid 1.36 points or -5.58% ending at 23.03.
The implied volatility indicators suggest selling pressure decreased during the week as both of the major indexes approached and tested their 50-day Moving Averages. They could go in either direction so for now it's wait and see mode. The IVXM chart shows a modest decline while the SPX chart shows it declined to the 50-day Moving Average.
VIX Futures Premium
This next chart shows as our calculation of Larry McMillan’s day-weighted average between the first and second month futures contracts as of last Friday.
With just two trading days until September expiration, the day-weighted premium between September and October allocated 10% to September and 90% to October for a premium of 16.55%. The premiums on Fridays before expiration are abnormally high and then quickly dissolve on Monday and Tuesday. The volume-weighted version at 7.99% usually gives a better reading on these pre-expiration Fridays.
The premium measures the distance from the VIX to the average of the two front month's futures, above or below the cash VIX, (contango or backwardation) until front month futures contract converges with the VIX at the next monthly futures expiration on Wednesday September 16, 2020. When the VIX spikes higher than the futures the premium turns negative and becomes unstable. From observation, here are the zones. Less than 0 = Red Zone associated with market declines, between 0 and 10% = Yellow Zone, between 10% and 20% = Green Zone, above 20% Super Green and unstable.
The relationship of the futures curve to the VIX, as measured by the premium, makes a good real-time sentiment indicator based upon actual commitments of large Asset Managers and Leveraged Funds.
For daily updates, follow our end-of- day volume weighted premium version located about halfway down the home page in the Options Data Analysis section on our website.
Foremost Indicators
VIX 10-day Correlation Indicator Update
Last week Digest Issue 36 "Speculative Crescendo [Charts]" included a chart showing how the abnormal correlation between the SPX and the VIX generated an early warning signal of the upcoming decline.
Digest Issue 35 "New Highs Everyday [Charts]'' explained the inverse relationship between the SPX and the VIX and the significance when it turns positive.
Now back to -.50 and again moving inversely with the SPX, another positive turn would suggest rising expectation of another leg down for the SPX.
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, continued declining last week by another 202.58 points or -37.21% ending at 341.89 on a downward trajectory and well below the 50-day Moving Average at 711.53 and now below the 200-day Moving Average at 384.59.
In the past, advances above and declines below, the moving averages, first the 50-day and then the 200-day have been good leading trend change indictors. Until this indicator stabilizes and turns up prudence suggests hedging or reducing long risk in overbought sectors.
Trade Ideas
One question frequently asked is where to find trade ideas. Since it's been a long time, a Top 5, review follows.
For ideas, we often look at the top 5 stocks based on the Implied Volatility Index Mean vs. the 30-day Historical Volatility (IV Index Mean vs. 30D HV) and the Top 5 stocks with greatest IV change from yesterday.
Here are Friday's results.
At the top, LCA (Lancadia Holdings II Inc.) is a SPAC, or Special Purpose Acquisition Company that it has entered into a purchase agreement to acquire Golden Nugget Online Gaming, Inc. and is expected to close in the 3rd quarter of 2020. This is an interesting situation involving seasoned well-capitalized operators.
The implied volatility reflects option activity anticipating the deal closing. Most of the volume and open interest are calls and some spreads can be identified, but many unhedged calls could be at risk of a substantial decline in implied volatility if and when the transaction closes.
For alternatives anticipating declining implied volatility consider selling out-of-the-money puts, for example using Friday's prices, the November 20 12.5 put for 1.35 with implied volatility of 130.50, with the stock closing at 17.74. Of course it comes with the risk of assignment should the stock decline below 12.50. In that event, the next step would be selling calls on long stock with a basis of 11.15 (12.50 -1.35) although the implied volatility could be lower.
The Top 5 regularly provides interesting ideas to research. This week beside LCA there are eight others to consider, each with their own story, opportunity and risk
Strategy
With an ordinary pullback underway and with the leading indexes at their 50-day Moving Averages the market breadth indicator suggests more downside, but it would likely start turning up if the 50-day Moving Averages contain the decline. If not, and they begin closing below support at their 50-day Moving Averages, the SPX could find some additional support around 3200 and then the 200-dayMoving Average at 3097.51.
Consider hedging longs especially in the tech sector since a major tech induced sell off will not spare other sectors, as was the case in early 2000.
In the meanwhile, look at the Top 5 ranker sample for special situation ideas that may be less sensitive to the tech sector and the major averages.
Beware, the seasonal record for September favors the bears. Even the lyrics to the old September Song referred to the shorts. "But the days grow short when you reach September."
Summary
Declines to their 50-day Moving Averages for both the S&P 500 and Invesco QQQ Trust confirm the anticipated tech induced pullback has begun. It could become obvious this week if "buy the dippers" can prevail and turn the markets higher or if the pullback becomes a more serious correction. Since nobody knows and the September seasonal favors the bears, prepare for either outcome by hedging longs in overbought sectors while considering special situation opportunities.
Disclaimer: IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter ...
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