Volume 15 Issue 15
Earnings, US Dollar Index, DJ Transports [Charts]

Last week was a buy the dip story, this week it will all be about earnings reports especially from large multinationals with significant foreign exchange risk. While the technical picture of the S&P 500 Index improved in the last two weeks, going into earnings reporting estimates have been lowered so uncertainty revolves around how many companies will beat lowered estimates and how many will still disappoint considering the strong dollar headwind.

Updated S&P 500 Index and DJ Transports charts below, detail the improved technical condition, while the US Dollar Index chart suggests strength will continue. Following the brief market review, we offer another long idea for PowerShares DB US Dollar Bullish ETF (UUP)

S&P 500 Index (SPX) 2102.06 was up 35.10 or -1.7% for the week after reversing and turning higher from just below the current operative upward sloping trendline. The next objective is the March 23 high at 2114.86 that defines a potential right shoulder of a Head & Shoulders Top shown in the chart below since a picture paints a thousand words.

The current operative upward sloping trendline, USTL begins at the October 15 low of 1821.61touching the February 2 low at 1980.90 with a slop of 1.44 per day. The secondary upward sloping trendline labeled USTL 2, the orange dotted line currently crossing at 1947.28 is the longer-term trendline that begins from the November 16, 2012 low of 1343.35 touching the October 15 low. In the event of a correction, USTL 2 should provide considerable support.

CBOE Volatility Index® (VIX) 12.58 down 2.09 for the week and appears headed lower.

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.

With only two trading days remaining for the April futures, the day weighting applied 25% to April and 75% to May as of Friday for an 18.44 % 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 14.37 %. 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 premiums ranged from 8.68% Tuesday to 14.41% Thursday, closing at 14.37% Friday thereby suggesting the current uptrend will continue consistent with an attempt to reach the March 23 objective high at 2114.86.

VIX Options

With a current 30-day Historical Volatility of 86.74 and 86.43 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.

Friday the implied volatility index was 60.73 and when compared to the current range historical volatility of 86.43, both the April and May at-the-money options appear inexpensive making May calls attractive for those seeking a hedge going into earnings.

Here is a chart showing declining VIX implied volatility and the relative relationship between the IV Index Mean and the 30-day Historical Volatility.

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Next, the important US Dollar Index:

US Dollar Index (DX) 99.34 with a 1.80 point or 1.86% gain for the week the uptrend resumes after pulling back from the high made on March 13 at 100.39.

The current upward sloping trendline begins at the December 16 low of 87.63 touching the February 26 low of 94.06. The recent pullback tested the USTL, then made what appears to be a double bottom before resuming the uptrend. With the current momentum, a test of at the previous high at 100.39 is likely this week, unless interrupted by macro economic developments. Accordingly, there is an option trade suggestion using UUP for DXY below.

First updating the also important Dow Jones Transportation Index:

iShares Transportation Average (IYT) 157.11, up 2.85 or 1.85% for the week this ETF tracks the important Dow Jones Transportation Average Index measuring the performance of transportation sector US equities.

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 recent weakness could be a function of bad winter weather and the previous West Coast port strike, both no longer important.

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 remained in a well-defined range between 155 and 166. After closing below the important 155 level for several days it now appears to be back into the range thereby supporting the bullish market view.

Going into earnings, the benefit of the doubt goes to the trend supported by the historical record of higher prices in April and May especially since the reoccurring practice is to reduce earnings estimates before reporting begins so they can be exceeded and justify higher stock prices. However, Crestmont Research reports as of 3-31-15 the current S&P 500 Index price-to-earnings ratio was 20.2 while the normalized Shiller ratio was 26.6 adding the “current status as near significantly overvalued.”

As for crude oil, while continued dollar strength will hinder further advances current data from the Commitment of Traders report suggests the commercials are becoming less bearish just as the small traders shown as Non-reportable positions have increased their net short position. This seems to support the view that crude oil has made a bottom since the commercials are usually right while small individual traders are usually wrong near important tops and bottoms.

In the meanwhile, attention turned to China and the relationship between China A shares traded in Shanghai and the Hong Kong H shares trading at a 24% discount as both roared higher last week. Watch for a pull back and then consider an out-of-the-money call spread using iShares China Large-Cap (FXI) 50.79 the best China ETF for options liquidity.

Back to the dollar:

PowerShares DB US Dollar Bullish ETF (UUP) 26.17

Referring to DXY chart the UUP equivalent for the DXY high at 100.39 is 26.50 just .33 higher than the current level.

The current Historical Volatility is 13.03 and 6.77 using the Parkinson’s range method, with an Implied Volatility Index Mean of 10.43 down from 11.12 the week before. The 52-week high was 11.32 on March 17, 2015 while the low was 3.75 on July 28, 2014. The implied volatility/historical volatility ratio using the range method is 1.54 so option prices are relatively high compared to the recent movement of the ETF. Friday’s option volume was 21, 172 contracts traded compared to the 5-day average volume of 41,990. The put open interest at 510K exceeded the call open interest of 347K contracts.

Although the options are priced high relative to the movement of the ETF, there is not enough premium in the higher strike to make a decent spread. Therefore, consider this long call only idea.

At the current price two longs call with have a delta just over 1.13 with very little loss of time value. Use a close back below 26 as the first warning and a close back below the last pivot at 25.50 as the SU (stop/unwind).

With a narrow bid/ask spread be prepared to pay the ask price. 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

This week it’s all about earnings reports assuming no unfavorable macro events distract attention. Following the regular practice of reducing estimates before reporting begins with the expectation of taking prices higher on better than expected, but reduced estimates, the focus will be on the multinationals with US dollar exposure. In the meanwhile, both the trend and the seasonal tendency favor somewhat higher prices although valuations now appear high so further gains may be limited by both valuations and the dollar.