Volume 14, Issue 11
St. Patrick’s Day

On this day, many parts of world celebrate Irish heritage and culture from Irish Pubs where possible since by tradition there are no Lenten drinking restrictions for the day. However, the bears are more likely to be celebrating than the bulls since most indicators show equities again turned negative last week with a few exceptions.

We begin with our market review followed by a review of last week’s alternative energy ideas for FuelCell Energy Inc. (FCEL) and Plug Power Inc. (PLUG). Then after a brief strategy comment, we look at SPDR Gold Shares (GLD) and have a new idea for iShares Silver Trust (SLV) both trending higher.

S&P 500 Index (SPX) 1841.13. Last week, in Digest Issue 10 “Volatility Kings Preview” we were encouraged by the ability of the Dow Jones Transports to exceed the previous January 23 high and noted the Dow Jones Industrial only need to advance less than 1% in order to exceed its December 31 high. However, economic news from China along with more concerns about Ukraine materially dimmed the picture as the Dow Jones Industrials along with the other important indexes closed the week lower.

CBOE Volatility Index® (VIX) 17.82. Through Wednesday of last week, VIX seemed unconcerned but that changed Thursday and Friday as it quickly advanced 3.71 for the week.

The table below shows the VIX cash compared to the next two futures contracts as well as our calculation of Larry McMillan’s day-weighted average between the first and second months.

Since the March contract expires Tuesday only one trading day remains, so the day weighting applies 5% to March and 95% to April for an average negative premium of 3.87. Our alternative volume-weighted average between March and April, regularly found in the Options Data Analysis section on our homepage, is slightly higher at -2.36%. Negative premiums reflect an unstable inverted term structure and signal an imminent change in direction for the S&P 500 Index. However, in the recent past, negative premiums have persisted for more than two weeks.

VIX Options

With a current 30-day Historical Volatility of 118.37 and 79.61 using Parkinson’s range method, the table below shows the Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon Friday’s closing option mid prices along with their respective month’s futures prices, since the options are priced from the tradable futures.

Monday is the last trading day for March options and compared to the range historical volatility of 79.61 suggests they are relatively expensive reflecting concern about a continuing SPX decline further confirmed by the low put-call ratio of .19 compared to last week’s .30.

CBOE S&P 500 Skew Index (SKEW) 112.66. SKEW measures the purchase of out-of-the-money S&P 500 Index puts that require a very large downside move to profit from long put positions. An increase of this index indicates greater expectations for an extreme down move.

Friday SKEW suddenly declined 15 points taking it back down near the May 28, 2013 low of 112.47. This unusual decline makes us wonder if there may have been a data problem. Here is the chart.

If the data is correct it suggests those that had been hedging against a large down move with puts have suddenly closed their puts, which seems unlikely considering the marco concerns but this is a contrarian indicator. Interestingly, the May 28, 2013 low at 112.47, shown above occurred less than a month before the S&P 500 Index made the June 24, 2013 closing low of 1573.09.

US Dollar Index (DX) 79.45. Now in downtrend, DX appears headed back down to test the 79 low made on October 25, 2013. This seems to suggest lower interest rates along with lower crude oil and equity prices on expectations for a slowing global economy.

10-Year Treasury Notes (TNX) yield 2.64% after reaching 3.03 on December 31. After spiking up to close at 2.79 on March 7, rates declined all last week along with equities suggesting China slowdown news along with seasonal weather factors were the cause. Referring to iShares Barclays 7-10 Year Treasury ETF (IEF) 102.47, some analysts are watching a potential Head & Shoulders Top giving importance to any close above the March 3 high at 102.83 negating the pattern meaning bond prices could continue higher reflecting continuing equity liquidation. Carefully watch IEF this week.

iShares Dow Jones Transportation Average Index (IYT) 134.12. One of the factors that influenced our positive outlook for equities last week in Digest Issue 10 “Volatility Kings Preview” was the ability of the transports to close above the January 23 high at 135.93 on Friday March 7 and thus confirm the S&P 500 Index breakout. Then last Tuesday after closing once again above 135.93 it turned lower and then made a decisive 1.74 point decline Thursday again reflecting expectations for a slowing economy.

NYSE McClellan Summation Index 938.33. The summation index is an intermediate indicator comprised of a running total of the McClellan oscillator, a leading indicator, which is the difference between a 19 period and a 39 period exponential moving average of the net difference between the advancing and declining issues on the New Your Stock Exchange. Although higher by 13.96 points since our last review in Digest Issue 9 “Index Disharmony”, it declined every day last week.

While not a lot of analysis was needed to determine that China slowing and Ukraine news negatively affected equity prices last week, there were also signs of rotation out of some leading sectors that is a concern especially when initial public offerings like Castlight Health (CSLT) 39.80 are selling at more than 100 times revenue. It seems the proceeds from the sales of what had been working are going into anything offering the opportunity for growth regardless of the price. Last week’s frantic run up the fuel cell stocks is another example. Then there are the Marijuana stocks along with Facebook’s (FB) $19bn acquisition of WhatsApp all suggesting we have entered bubble territory a la 2000. Along these lines, we opened a new “Bubble” file last week to begin tracking them as the bubble expands, so expect to see more examples. We know how the bubble story ends so be careful.

Fuel Cell Crazy Review

Last week’s we offered two suggestions for stocks in the long dormant fuel cell sector that we noted by the increasing call volume and implied volatility in Actionable Options™. While they brought back memories of the dot.com era, we were unprepared for the advances both made on such scary high volume it prompted this thought.

“I had a plan until I got hit in the mouth.” Mike Tyson

In this case, the extreme price and volume advances last Monday confirmed our dot.com bubble suspicions thereby cancelling the plans.

During the week, considerable more fundamental information including a report from Citron Research became available to help with the analysis, in addition Plug Power Inc. (PLUG) 6.71 reported what appears to be inline negative earrings of .08 per share. Imagine the stock went from 4.60 on March 3 to 11.72 on March 11 on more volume than there are shares outstanding on both March 10 and March 11 before reporting an inline loss. We have seen the fuel cell movie before.

Gold and Silver Alternatives

While it may be premature to consider short positions such as put spreads or VIX calls, an alternative could be long gold and silver positions since they are both in well-defined uptrends and seem to be responding to the weak dollar and lower interest rates suggesting slowing economic activity.

SPDR Gold Shares (GLD) 133.10.

iShares Silver Trust (SLV) 20.62.

While both have good options volume, we will focus on SLV since the price is lower, providing a lower cost opportunity although the GLD uptrend is better defined.

First the option details,

The current Historical Volatility is 24.46 and 14.16 using the Parkinson’s range method, with an Implied Volatility Index Mean of 28.60, up from 25.93 the week before. The 52-week high was 49.93 on April 15, 2013 while the low was 18.90 on March 27, 2013. The put-call ratio at .31 is bullish with 3 times more calls traded than puts. The implied volatility ratio compared to the range historical volatility at 2.02 suggests options are expensive so we want to use a spread combination. Friday’s volume was high at 118,501 contracts traded compared to the 5-day average volume of 73,990 contracts.

Here is a low cost call spread risk reversal to consider.

Use a close below the last pivot at 20 as the SU (stop/unwind) or be prepared to take the stock by assignment in the event it closes below 20 on the April expiration.

The suggestion above uses the closing middle price between the Friday bid and ask. Monday option prices will be somewhat different due to the time decay over the long weekend and any price change.

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Summary

Last week in Digest Issue 10 “Volatility Kings Preview” we concluded equities we likely to continue higher the exact opposite of the actual results. Thus, the possibility for a further decline in the weeks ahead has increased again especially since there are signs of rotation and bubbles are beginning to appear in IPOs along with some other sectors increasing the chances for the long awaited 10% correction. The markets are again signaling slower economic activity ahead. In addition, they will be responding to events in Ukraine.