AI
| Followers | 71 |
| Posts | 12229 |
| Boards Moderated | 1 |
| Alias Born | 04/01/2000 |
Sunday, March 20, 2011 1:49:21 PM
Monday Morning Outlook: Two Major Risk Factors for the Bulls
Option activity indicates that hedge funds may still be on the sidelines
by Todd Salamone 3/19/2011 3:04 PM
http://www.schaeffersresearch.com/commentary/observations.aspx?ID=105587&trackback=mmoezine
It was a wild ride in the equities market last week. Stocks spiraled relentlessly lower through Wednesday, as the nuclear crisis in disaster-stricken Japan rattled markets across the globe. Then, the major indexes spent the last two days of the week charging higher, bouncing back from their year-to-date breakeven levels. In the wake of this five-day roller-coaster ride, Todd Salamone pinpoints key technical areas to watch going forward -- as well as two serious points of concern for the bulls. Meanwhile, Rocky White explains why small-cap stocks were relatively unruffled by last week's bout of volatility.
What the Trading Desk Is Expecting: Days of Technical Reckoning Ahead
By Todd Salamone, Senior Vice President of Research
"Anything can happen during expiration week -- from delta-hedge selling related to the enormous put open interest below current levels, to a short-covering rally related to the expiration of the put open interest. Probabilities favor the short-covering rally, but watch out below if delta-hedge selling occurs...
"Bulls would prefer that the VIX remain below its 200-day moving average, at 21.85, and its 80-week moving average, currently situated at 22.27...
"Admittedly, there is a lot to digest this week. In our view, the long-term outlook remains bullish, but the short-term outlook still suggests choppy action between 1,300 and 1,333 for the SPX. If 1,300 breaks decisively, look for the 1,270 area to be the next level of support, as it's the site of the SPX's 80-day moving average."
Monday Morning Outlook, March 12, 2011
A brewing nuclear crisis in Japan was the catalyst for "watch out below!" expiration-week volatility this past week, with the S&P 500 Index (SPX – 1279.20) closing down 25 points, or 1.9%. In reviewing the price action driven by the Japan catalyst, one has to wonder: How much of the selling was related to expiration-week delta hedging? Delta hedging is a process in which sellers of index and exchange-traded fund (ETF) puts short S&P futures in order to maintain a neutral position, and heavy put strikes below act as magnets due to their increasing sensitivity to the decline in the underlying index or ETF.
We found it interesting, for example, that the SPDR S&P 500 ETF (SPY) was driven down to the 125 strike at Wednesday's lows, as this was the site of the last significant put open interest in the expiring March series. Even as headline news remained bleak, the ETF managed to bounce strongly -- perhaps due to the major delta-hedge selling being exhausted. As you can see in the chart below, the put open interest at the 123 and 124 strikes was minimal compared to the put open interest at the 125 through 128 strikes.
To the extent that some of last week's selling was driven by hedging activity related to the huge put open interest on expiring index and ETF options, it would favor the bulls, as investor anxiety climbed amid the selling. For example, the latest survey from the American Association of Individual Investors (AAII) revealed only 28% of those surveyed were bullish -- the lowest percentage of bulls since late August 2010, which was a buying opportunity.
Despite the rising fears, the SPX managed to close the week above its 80-day moving average, which we identified as a potential support area in the event of a decisive break below 1,300. The rising 80-day moving average enters this week's trading at 1,277.60. Coincidentally, this area marks a 50% retracement of the prior week's close and last week's low.
Moreover, we found it interesting that the SPX, Dow Jones Industrial Average (DJIA – 11,858.52) and Russell 2000 Index (RUT – 794.66) pulled back to their respective breakevens for the year, and closed the week in positive territory after rallying from these year-to-date breakeven numbers -- which are 1,257.64, 11,577.51 and 783.65, respectively. The Nasdaq Composite (COMP – 2,643.67), however, closed the week barely in negative year-to-date territory, below its Dec. 31, 2010 close at 2,652.87.
These "year-to-date" breakeven numbers can be viewed as potential support for the upcoming week. Meanwhile, potential resistance levels would be the familiar round-number areas, such as 12,000 on the Dow, 1,300 on the SPX and 800 on the RUT.
The two major risk factors working against the bulls in the short term are:
1. Volatility, as measured by the CBOE Market Volatility Index (VIX – 24.44), is rising. We noted in prior weeks that bulls should be encouraged by the fact that the VIX was getting capped at long-term trendlines, such as its 200-day and 80-week moving averages, which are situated at 21.69 and 22.26, respectively. While the VIX peaked in the 30 area around mid-week, we won't have confirmation that a top has been reached until we see a decline below these long-term trendlines and the 20 level. Finally, it is interesting that the VIX's peak at 31.28 last week is approximately double the lows that have been in place since mid-December.
2. Another concern is that our analysis of activity in the options market indicates that hedge funds are still not showing interest in accumulating equities. And if retail investors continue to bail, as they have done during the past couple of weeks, this absence of institutional and retail interest could create a challenge for equities in the near term.
One alternative you could consider amid the global uncertainty is a stock-replacement strategy, where you sell stocks that you like and buy in-the-money or longer-dated call options on those same equities. We noticed equity implied volatilities did not experience the pop that index implied volatilities experienced last week. Therefore, many equity options remain reasonably priced.
Options allow you to put less dollars at risk, but offer you returns that are a multiple of the comparable return on the underlying equity. This strategy allows you to participate in a rally if volatility has peaked, while simultaneously exposing fewer dollars to the market. If you are looking for equity put plays, we recommend hunting in the large-cap technology space, as hedge funds appear to be bailing on these equities.
Indicator of the Week: Measuring Investor Reactions to Japan's Disaster
By Rocky White, Senior Quantitative Analyst
Foreword: Stock markets were jolted last week, as a nuclear crisis unfolded in the wake of an earthquake and tsunami in Japan the previous Friday. U.S. markets fell especially hard on Tuesday and Wednesday, before paring their losses in the last few days of the week. In the analysis below, I show how investors have reacted to the disaster by looking at returns of some major exchange-traded funds (ETFs). We'll also consider what implications these reactions might have going forward.
Prior Bull Markets: Below is a list of ETFs I thought would be interesting to consider. The table displays their returns through Wednesday of last week, which is the day the Dow fell 240 points and bottomed. Then you'll see the returns following Wednesday, when the market gained back a significant number of points.
Obviously, the ETF most affected was the iShares MSCI Japan Index Fund (EWJ), which tracks Japanese stocks. It fell over 10% through Wednesday of last week, before gaining back over 7% over the next two days. Japan's currency action was a surprise to some people, as the yen actually moved significantly higher immediately after the disaster. This was on speculation that Japanese money will be repatriated as they rebuild.
Also interesting was the behavior of major U.S. indexes. The small-cap stocks are typically the most volatile. They fall the most in bad times, and rise the most in good times. However, the iShares Russell 2000 Index (IWM), which tracks smaller companies, fell the least when the markets tumbled. This is probably because the big-cap stocks generate more revenue from overseas, and are therefore more affected by a fall in demand from Japan.
The other ETFs listed show that oil and gold fell after the disaster, but gained most of it back when markets rebounded. Bonds increased significantly, as investors looked for safe places to put their money.
Post-Japan ETF performance
Option Activity: Another effect of the disaster which may be supportive of the market is that it spooked a lot of investors to put hedges in place. Look at the chart below, which shows April-dated put open interest for the SPDR S&P 500 ETF (SPY). I show the open interest prior to last week (as of March 11), as well as open interest at the end of last week. For the strikes immediately below the price of the SPY (strikes 123-127), the amount of put open interest nearly doubled from the beginning of the week until the end of the week. These added puts support the market, because if portfolios are hedged, then losses aren't as severe when the market declines -- making the portfolio managers less likely to panic sell, which can drive the markets even lower. These put options were possibly purchased as investors prepared for the worst. And the contrarian in us knows that the market rarely does what the crowd is most prepared for.
This Week's Key Events: Housing Stats and Fourth-Quarter GDP on Tap
Schaeffer's Editorial Staff
Here is a brief list of some of the key events this week. All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.
Monday
* We kick off the week with February's existing home sales, along with quarterly earnings from Tiffany & Co. (TIF) and Feihe International (ADY).
Tuesday
* Weekly chain store sales are on the economic calendar, as well as the Richmond Fed manufacturing survey for February. On the earnings front, we'll hear from Carnival (CCL), Dollar General (DG), and Walgreen Company (WAG).
Wednesday
* New home sales for December will hit the Street on Wednesday, as will the regularly scheduled update on domestic petroleum supplies. The earnings calendar brings us the latest quarterly results from General Mills (GIS), Paychex (PAYX), and Red Hat (RHT).
Thursday
* Durable goods orders for February and weekly jobless claims are due out Thursday. A few heavy hitters are scheduled to step up to the earnings plate, including Best Buy (BBY), ConAgra (CAG), Oracle (ORCL), and Research In Motion Limited (RIMM).
Friday
* The week wraps up with the final estimate on fourth-quarter gross domestic product (GDP), as well as the late-March Reuters/University of Michigan consumer sentiment report. There are no major earnings reports on the docket.
Option activity indicates that hedge funds may still be on the sidelines
by Todd Salamone 3/19/2011 3:04 PM
http://www.schaeffersresearch.com/commentary/observations.aspx?ID=105587&trackback=mmoezine
It was a wild ride in the equities market last week. Stocks spiraled relentlessly lower through Wednesday, as the nuclear crisis in disaster-stricken Japan rattled markets across the globe. Then, the major indexes spent the last two days of the week charging higher, bouncing back from their year-to-date breakeven levels. In the wake of this five-day roller-coaster ride, Todd Salamone pinpoints key technical areas to watch going forward -- as well as two serious points of concern for the bulls. Meanwhile, Rocky White explains why small-cap stocks were relatively unruffled by last week's bout of volatility.
What the Trading Desk Is Expecting: Days of Technical Reckoning Ahead
By Todd Salamone, Senior Vice President of Research
"Anything can happen during expiration week -- from delta-hedge selling related to the enormous put open interest below current levels, to a short-covering rally related to the expiration of the put open interest. Probabilities favor the short-covering rally, but watch out below if delta-hedge selling occurs...
"Bulls would prefer that the VIX remain below its 200-day moving average, at 21.85, and its 80-week moving average, currently situated at 22.27...
"Admittedly, there is a lot to digest this week. In our view, the long-term outlook remains bullish, but the short-term outlook still suggests choppy action between 1,300 and 1,333 for the SPX. If 1,300 breaks decisively, look for the 1,270 area to be the next level of support, as it's the site of the SPX's 80-day moving average."
Monday Morning Outlook, March 12, 2011
A brewing nuclear crisis in Japan was the catalyst for "watch out below!" expiration-week volatility this past week, with the S&P 500 Index (SPX – 1279.20) closing down 25 points, or 1.9%. In reviewing the price action driven by the Japan catalyst, one has to wonder: How much of the selling was related to expiration-week delta hedging? Delta hedging is a process in which sellers of index and exchange-traded fund (ETF) puts short S&P futures in order to maintain a neutral position, and heavy put strikes below act as magnets due to their increasing sensitivity to the decline in the underlying index or ETF.
We found it interesting, for example, that the SPDR S&P 500 ETF (SPY) was driven down to the 125 strike at Wednesday's lows, as this was the site of the last significant put open interest in the expiring March series. Even as headline news remained bleak, the ETF managed to bounce strongly -- perhaps due to the major delta-hedge selling being exhausted. As you can see in the chart below, the put open interest at the 123 and 124 strikes was minimal compared to the put open interest at the 125 through 128 strikes.
To the extent that some of last week's selling was driven by hedging activity related to the huge put open interest on expiring index and ETF options, it would favor the bulls, as investor anxiety climbed amid the selling. For example, the latest survey from the American Association of Individual Investors (AAII) revealed only 28% of those surveyed were bullish -- the lowest percentage of bulls since late August 2010, which was a buying opportunity.
Despite the rising fears, the SPX managed to close the week above its 80-day moving average, which we identified as a potential support area in the event of a decisive break below 1,300. The rising 80-day moving average enters this week's trading at 1,277.60. Coincidentally, this area marks a 50% retracement of the prior week's close and last week's low.
Moreover, we found it interesting that the SPX, Dow Jones Industrial Average (DJIA – 11,858.52) and Russell 2000 Index (RUT – 794.66) pulled back to their respective breakevens for the year, and closed the week in positive territory after rallying from these year-to-date breakeven numbers -- which are 1,257.64, 11,577.51 and 783.65, respectively. The Nasdaq Composite (COMP – 2,643.67), however, closed the week barely in negative year-to-date territory, below its Dec. 31, 2010 close at 2,652.87.
These "year-to-date" breakeven numbers can be viewed as potential support for the upcoming week. Meanwhile, potential resistance levels would be the familiar round-number areas, such as 12,000 on the Dow, 1,300 on the SPX and 800 on the RUT.
The two major risk factors working against the bulls in the short term are:
1. Volatility, as measured by the CBOE Market Volatility Index (VIX – 24.44), is rising. We noted in prior weeks that bulls should be encouraged by the fact that the VIX was getting capped at long-term trendlines, such as its 200-day and 80-week moving averages, which are situated at 21.69 and 22.26, respectively. While the VIX peaked in the 30 area around mid-week, we won't have confirmation that a top has been reached until we see a decline below these long-term trendlines and the 20 level. Finally, it is interesting that the VIX's peak at 31.28 last week is approximately double the lows that have been in place since mid-December.
2. Another concern is that our analysis of activity in the options market indicates that hedge funds are still not showing interest in accumulating equities. And if retail investors continue to bail, as they have done during the past couple of weeks, this absence of institutional and retail interest could create a challenge for equities in the near term.
One alternative you could consider amid the global uncertainty is a stock-replacement strategy, where you sell stocks that you like and buy in-the-money or longer-dated call options on those same equities. We noticed equity implied volatilities did not experience the pop that index implied volatilities experienced last week. Therefore, many equity options remain reasonably priced.
Options allow you to put less dollars at risk, but offer you returns that are a multiple of the comparable return on the underlying equity. This strategy allows you to participate in a rally if volatility has peaked, while simultaneously exposing fewer dollars to the market. If you are looking for equity put plays, we recommend hunting in the large-cap technology space, as hedge funds appear to be bailing on these equities.
Indicator of the Week: Measuring Investor Reactions to Japan's Disaster
By Rocky White, Senior Quantitative Analyst
Foreword: Stock markets were jolted last week, as a nuclear crisis unfolded in the wake of an earthquake and tsunami in Japan the previous Friday. U.S. markets fell especially hard on Tuesday and Wednesday, before paring their losses in the last few days of the week. In the analysis below, I show how investors have reacted to the disaster by looking at returns of some major exchange-traded funds (ETFs). We'll also consider what implications these reactions might have going forward.
Prior Bull Markets: Below is a list of ETFs I thought would be interesting to consider. The table displays their returns through Wednesday of last week, which is the day the Dow fell 240 points and bottomed. Then you'll see the returns following Wednesday, when the market gained back a significant number of points.
Obviously, the ETF most affected was the iShares MSCI Japan Index Fund (EWJ), which tracks Japanese stocks. It fell over 10% through Wednesday of last week, before gaining back over 7% over the next two days. Japan's currency action was a surprise to some people, as the yen actually moved significantly higher immediately after the disaster. This was on speculation that Japanese money will be repatriated as they rebuild.
Also interesting was the behavior of major U.S. indexes. The small-cap stocks are typically the most volatile. They fall the most in bad times, and rise the most in good times. However, the iShares Russell 2000 Index (IWM), which tracks smaller companies, fell the least when the markets tumbled. This is probably because the big-cap stocks generate more revenue from overseas, and are therefore more affected by a fall in demand from Japan.
The other ETFs listed show that oil and gold fell after the disaster, but gained most of it back when markets rebounded. Bonds increased significantly, as investors looked for safe places to put their money.
Post-Japan ETF performance
Option Activity: Another effect of the disaster which may be supportive of the market is that it spooked a lot of investors to put hedges in place. Look at the chart below, which shows April-dated put open interest for the SPDR S&P 500 ETF (SPY). I show the open interest prior to last week (as of March 11), as well as open interest at the end of last week. For the strikes immediately below the price of the SPY (strikes 123-127), the amount of put open interest nearly doubled from the beginning of the week until the end of the week. These added puts support the market, because if portfolios are hedged, then losses aren't as severe when the market declines -- making the portfolio managers less likely to panic sell, which can drive the markets even lower. These put options were possibly purchased as investors prepared for the worst. And the contrarian in us knows that the market rarely does what the crowd is most prepared for.
This Week's Key Events: Housing Stats and Fourth-Quarter GDP on Tap
Schaeffer's Editorial Staff
Here is a brief list of some of the key events this week. All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.
Monday
* We kick off the week with February's existing home sales, along with quarterly earnings from Tiffany & Co. (TIF) and Feihe International (ADY).
Tuesday
* Weekly chain store sales are on the economic calendar, as well as the Richmond Fed manufacturing survey for February. On the earnings front, we'll hear from Carnival (CCL), Dollar General (DG), and Walgreen Company (WAG).
Wednesday
* New home sales for December will hit the Street on Wednesday, as will the regularly scheduled update on domestic petroleum supplies. The earnings calendar brings us the latest quarterly results from General Mills (GIS), Paychex (PAYX), and Red Hat (RHT).
Thursday
* Durable goods orders for February and weekly jobless claims are due out Thursday. A few heavy hitters are scheduled to step up to the earnings plate, including Best Buy (BBY), ConAgra (CAG), Oracle (ORCL), and Research In Motion Limited (RIMM).
Friday
* The week wraps up with the final estimate on fourth-quarter gross domestic product (GDP), as well as the late-March Reuters/University of Michigan consumer sentiment report. There are no major earnings reports on the docket.
Discover What Traders Are Watching
Explore small cap ideas before they hit the headlines.
