S&P 500 Index Update [Charts]

By the end of last week, the dovish “reasonably confident” comment that replaced “patient” seems to have worn off, since the US Dollar Index appears to have reversed after testing 96 as Federal Reserve Chair Janet Yellen now says a fed funds rate hike is likely this year, a widely held view by economic analysts. The Federal Reserve interest rate policy as well as earnings revisions resulting from the stronger dollar are the two most things to watch and earnings reporting begins in less than two weeks. In the meanwhile, the current S&P 500 Index technical picture suggests caution as it often does before earnings reporting.

The two charts in the strategy section below help explain the cautious viewpoint. First, the regular market review followed by updates on last week’s suggestions for both the CBOE Volatility Index® (VIX) and iShares Nasdaq Biotechnology (IBB).

S&P 500 Index (SPX) 2061.02 down 47.08 or -2.23% for the week as the last advance failed to exceed the previous high of 2119.59 made February 25 receiving little support until Friday from the now negatively correlated US dollar that declined until Thursday. From a classical bar chart technical perspective, there are several reasons to be cautious going into earnings reporting. See the charts below for details.worthwhile.

CBOE Volatility Index® (VIX) 15.07 up 2.05 for the week and unless SPX downward momentum increases Monday it will likely settle into a narrow range for the rest of this holiday short trading 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.

The day weighting applies 60% to April and 40% to May for an 11.64 % premium shown above. Our alternative volume-weighted average between April and May, regularly found in the Options Data Analysis section on our homepage, is slightly lower at 11.01%. Premiums for normal term structures are 10% to 20%. 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 oversold conditions. Last week the premium began at 23.68%, the third day above 20% and remained high through Tuesday at 20.70%. Wednesday it was back into neutral territory at 10.66%.

VIX Options

With a current 30-day Historical Volatility of 88.06 and 85.50 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 75.69 and comparing the current range historical volatility of 85.50, to the April at-the-money options they appear about right while the May options are slightly less expensive.

CBOE S&P 500 Skew Index (SKEW) 121.80 – 9.29 for the week, 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.

Market Breadth

Updating market breadth, for the week, the McClellan Oscillator Summation Index reported by McClellan Financial Publications closed almost unchanged at 2136.26 declining 34.42.

US Dollar Index (DX) 97.29 the modest .62 decline for the week misses the story about this now most important variable. Last Monday it dropped below a well-formed symmetrical triangle as could have been expected. By Thursday, the decline had extended down to 96.17, but did not reach the downside measuring objective defined by the symmetrical triangle. Then reversing and turning higher to close up .46 on the day it seemed to sense the upcoming comments by Chair Janet Yellen on Friday, that a fed funds rate hike “may well be warranted later this year.” How did the FX market know in advance? Hum!

iShares Transportation Average (IYT) 156.00 tracks the Dow Jones Transportation Average Index measuring the performance of transportation sector US equities.

After making a high at 167.80 on November 28, it retested the 165 – 166 area four times failing to reach 167.80 on each attempt despite continuing advances of both the DJ Industrials and the broad based S&P 500 Index both moving to new highs while IYT remains in a well-defined range between 155 and 166. Watch for any close below 155 as sign of continued weakness.

According to the widely followed Dow Theory, the transports and the Dow Jones Industrial Average should move in the same direction while divergences could signal a possible trend change so from a Dow Theory perspective, the current divergence is worrisome for the bulls. However, they will likely attribute the current weakness as temporary due to a combination of bad winter weather and the West Coast port strike, both no longer important.

While the VIX Futures premium moved back into neutral territory after giving sell signals for four days, some additional caution may still be wise since Mondays are traditionally weak. However, seasonally April and May are good for equities and the biotech sector that had been leading the market high before pulling back last week looks like it tested support and reversed higher last Thursday. Now updating the S&P 500 Index charts:

The current operative upward sloping trendline, USTL begins at the October 15 low of 1821.61with Friday’s close just back above the trendline acting as support as it often does. In addition, the widely followed 50-day moving average (not shown) is just above at 2064.99. However, there is a potential Head & Shoulders Top in the works with the left shoulder defined by the December 29 high at 2093.55 marked LS above. The Head is the February 25 high at 2119.59 and the right shoulder RS marks the March 23 high at 2114.86. An alternative interpretation could be a double top defined by the Head and RS. While the uptrend defined by the USTL may now continue higher, a potential Head & Shoulder Top remains the operative pattern until there is a close back above the February 25 high of 2119.59.

There is another possibility:There is another possibility:

In classical bar chart analysis, a Rising Wedge is a minor or at most an intermediate pattern with respect to trend implications.

Edwards & Magee says,

Could be S&P 500 Index becoming progressively weaker in the technical sense or is this just another typical lull before earnings reports begin?

John Murphy adds,

So, if this is a rising wedge, it may take longer to form.

However, since 2009, most foreboding technical patterns have been resolved by the markets continuing higher and it could well be the case once again. Perhaps this is just another example of “the darkest hour is just before the [earnings] dawn.”

Also, be aware of the upcoming non-farm payroll report scheduled for release Friday when US markets are closed. Then European markets will close next Monday so we may not get a full response to any employment report above or below the consensus estimate until Tuesday.

Progress Report

Last week in Digest Issue 12 “VIX Futures Premium Hedge Indicator [Chart]” included two suggestions, the first a synthetic long hedge using April 16 CBOE Volatility Index® (VIX) options.

VIX April 16 Futures 16.25 -.23

Opening position: Last Monday’s closing price for the April 16 call was 1.30 ask and 1.15 bid for the April 16 put for a .15 debit.

Marked-to market Friday the April 16 call was 1.35 bid while the April 16 put was 1.15 ask for a .20 credit difference. After subtracting the original debit, the net marked-to-market gain was .05.

Now what? Unless the market declines and VIX makes a significant gain Monday, typically the weakest day of the week, we suggest closing the position since this is a short holiday trading week and volatility and volume will likely decline in the absence of an unknown dramatic event.

The second, a put spread on the overbought biotech ETF.

iShares Nasdaq Biotechnology (IBB) 347.46 +6.65

Since IBB declined 8.24 last Monday it may have discouraged some, thinking it was too late for a put spread. Using the ask for the long April 350 put at 7.00 and the middle price of 4.25 for the short April 340 put, assuming some price improvement, the net debit was 2.75.

The big down move was Wednesday as it declined another 14.65, but then reversed Thursday at the 340 support level then advanced more Friday. A properly prepared and executed trade plan that specified the 340 support, also the short April put strike, would have closed the position Thursday. If not, the advance Friday turned the position into a looser. At the close, marked-to-market was 1.75 for a 1.00 loss and it looks like the biotech pull back is over with IBB going higher so close any outstanding put spreads and consider a long call spread or even a synthetic long replacement.

Since biotech was recently one of the leading sectors, a further advance could add support for NASDAQ and S&P 500 Indexes offsetting the technical concerns detailed above. The operative word here is “could.”

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Summary

After dovish comments following the previous Federal Reserve Open Market Committee meeting the most recent comments made by Janet Yellen Friday seemed like an attempt to call the dove back while keeping uncertainty alive in an effort to keep the markets from going to another extreme in the opposite direction. If so, attempts to manage market expectations seem out of control, and will likely end poorly. In the meanwhile, with the help of the biotech sector the NASDAQ and S&P 500 Indexes look as if they will attempt to resume trending higher although there are some clearly identified technical hurdles to overcome, including the diverging transportation average index.