Volume 15 Issue 11
S&P 500, US Dollar and Crude Oil [Charts]

As the financial world anxiously awaits to see if “patient” remains in the comments from Federal Reserve Chair Janet Yellen after the Open Market Committee meeting Wednesday, the markets have decided to act first anticipating this most scrutinized word in recent memory will be gone thus clearing the way for a federal funds rate increase, perhaps as early as June. Of course, a good bit of the recent market action will likely reverse if the Federal Reserve once again surprises the markets by retaining “patient.” With the S&P 500 Index at an important support level, the US dollar dramatically overbought and crude oil testing the previous January low, there is a chance they all will reverse course, if only temporarily, regardless of the comments.

We have more in our market review below along with another hedge suggestion with CBOE Volatility Index® (VIX) options.

S&P 500 Index (SPX) 2053.40 down 17.86 or -.86% for the week it now rests right on the upward sloping trendline from the from the October 15 just below 2050. After a modest gain last Monday, it made another big down leg Tuesday as the now negatively correlated US dollar advanced both Tuesday and Wednesday. Thursday it looked like support from the upward sloping trendline would turn the tide, but more dollar strength Friday turned it lower once again. See the chart below for more details.

CBOE Volatility Index® (VIX) 16.00 up only .80 for the week it will likely continue higher Monday and Tuesday anticipating comments after the Federal Reserve meeting Wednesday.

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.

The day weighting applies 10% to March and 90% to April for a 10.84% premium shown above. Our alternative volume-weighted average between March and April, regularly found in the Options Data Analysis section on our homepage, is slightly lower at 7.16%. Premiums for a normal term structure are 10% to 20%; while premiums above 20% are unsustainable suggesting a lack of enthusiasm for VIX hedging often occurring around market highs suggesting overbought conditions associated with pullbacks. Alternatively, premiums less than 10% suggest caution and negative premiums indicate an oversold condition. Last week the premiums were between 5.37% and 9.90% all week.

S&P 500 Index Update

The now well-developed 3-point upward sloping trendline did a good job supporting last Tuesday’s 35.27-point decline and the retest that held again Friday. Additional support comes from the 50 day moving average now at 2059 and the 50% Fibonacci retracement of the advance up from the February 2 low at 2050, also the second point on the upward sloping trendline. For this current trend, the close Wednesday after the Federal Reserve comments will be of upmost significance.

VIX Options

With a current 30-day Historical Volatility of 98.65 and 84.00 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.

The implied volatility index was 81.33 so compared to the current range historical volatility of 84.00, both the March and April options appear about normal, except for the March 16 put that expires Wednesday is slightly inexpensive, but will have little premium remaining Monday.

CBOE S&P 500 Skew Index (SKEW) 120.60 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. The CBOE explains further, a Skew value of 100 means the perceived distribution of S&P 500 log-returns is normal so the probability of outlier returns is negligible. As Skew rises above 100, the left tail of the distribution acquires more weight increasing the probability of outlier returns.

Although recently declining it remains in range between the September 19, 2014 high of 146.08 and the October 15 low of 111.31 that occurred with the market low. Since the best signals are at the extremes, the current reading just below the current range midpoint of 128.70 provides little useful information about increased out-of-the-money put buying.

Market Breadth

Adding market breadth to the equation, for the week, the McClellan Oscillator Summation Index reported by McClellan Financial Publications closed at 2207.76 declining every day last week for a 651.51-point loss, not encouraging for the bulls.

US Dollar Index (DX) 100.33 while often positively correlated with equities that is not the case now as a higher dollar not only against the euro with a 58% weighting but also against the Japanese yen with a 14% weight and sterling at 12%. If there was one driving force moving in the markets last week this is it as attention turned to the upcoming Federal Reserve Open Market Committee meeting on Tuesday and Wednesday and the all important comments after the meeting Wednesday to see if the single word “patient” remains. The economists and analysts participating in this frenzy say the removal of “patient” from the comments means an increase in the federal funds can be expected as soon as June or perhaps September. With the European Central Bank now buying bonds, flooding the market with liquidity the interest rate differential has already widened and it would expect to increase further as the federal funds rate goes higher.

As expected the markets are anticipating the change in Federal Reserve policy and are busy altering portfolio allocations as evidenced by the decline in Treasury Bonds, Utilities, REITs, MLPs, commodities especially crude oil and multinational exporters who will need to reduce pricing in euros and yen in order to remain competitive. While there are a few beneficiaries, such as banks, brokers and insurers the initial reaction already underway is mostly negative for equities. The current operative trendline starts from the December 16 low at 87.63 touching the February 26 low at 94.06 just before the recent breakout to new highs. On an expected pull back, the USTL should act as support and there will be good support at 95 as shown on the chart.

If you shoot an arrow into the sky, it will eventually return to earth and the US Dollar Index looks like an arrow shot almost straight up after the nonfarm payroll report. We suggest a correction is likely to begin Monday or Tuesday regardless of the comments after the Federal Reserve Open Market Committee meeting Wednesday. Accordingly, we suggest closing any remaining PowerShares DB US Dollar Bullish ETF (UUP) longs or Utilities Select Sector SPDR ETF (XLU) shorts early in the week. However, chances are good for increasing equity implied Monday and Tuesday so for nimble traders here is a one day VIX options suggestion using April options since the March options end trading Tuesday. Then, like the dollar index, expect to see implied volatility decline Wednesday.

CBOE Volatility Index® (VIX) 16.00

Open Monday presuming VIX is higher, however if lower it likely means volatility is already being sold in anticipation of a further decline Wednesday so it may be too late. Expect to pay the ask price and then if opened plan to close it Tuesday at the bid.

Crude Oil Update

Light Sweet Crude Oil (CL) 44.84 basis April futures.

Based upon momentum here is our interpretation of an Elliott Wave count along with the downward sloping trendline. Presuming we are right and the overbought US Dollar Index pulls back chances are the 5th wave low may have been made. However, crude oil inventories continue to build so any bottom at the current level is contrary to comments from a number of analysts.

While the 5th wave bottom could still be at a lower level we suggest watching the downward sloping trendline DSTL that began as the downward momentum increased from the September 30 high at 91.36, the origin of the trendline. As an alternative, use the crude oil ETF United States Oil (USO) 16.80 having declined from 35.48 since September 30.

The suggestion above shows the closing bid and ask prices. For this underlying be prepared to pay the ask and sell at the bid. Monday’s option prices will be somewhat different due to the time decay over the weekend and any stock price change.

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Summary

Most all of the interest sensitive underlying issues appear at extremes some overbought like the US Dollar Index with crude oil oversold after the nonfarm payroll report, ahead of the Federal Reserve Open Market Committee meeting Wednesday. Chances are good for short-term counter trend moves going into the release of the comments after the meeting. The S&P 500 Index, currently testing the upward sloping trendline will likely determine if there will be change of the current trend.