From the Top

What to Do with the Sideways Trend in Small-Caps

The iShares Russell 2000 Index ETF (IWM) has been range-bound for months

by 2/2/2015 10:02 AM
Stocks quoted in this article:

The following is a reprint of the market commentary from the February 2015 edition of The Option Advisor, published on January 22. For more information or to subscribe to The Option Advisor, click here.

In a recent commentary to my "Chart of the Week" subscribers, I discussed a stiff layer of resistance that's emerged for the small-cap focused iShares Russell 2000 Index ETF (IWM). The $120 region has kept a lid on IWM for the better part of the past year, most likely because it represents the convergence of two significant technical levels.

Specifically, $120.18 represents double IWM's October 2011 low, while $122.10 represents a 50% gain from the fund's December 2012 trough. Given the tendency of investors to "take the money and run" at these kinds of significant percentage returns, it's no surprise that IWM peaked just north of $120 on three separate occasions last year -- in March, July, and December -- before retreating.

In addition to these formidable price points, IWM is now staring up at an accumulation of more than 63,000 calls in open interest at the newly front-month February 120 strike. This is not necessarily a colossal level of outstanding contracts by "index-based ETF" standards -- but, given IWM's nearly year-long battle with $120, it's certainly notable that this is the site of peak front-month call open interest.

Anecdotally, there seems to be a growing consensus that small-caps -- on the heels of a disappointing 2014, relatively speaking -- are set to resume a leadership role this year. Consider this selection of headlines from the last month:

"How US small caps will pay for my son's tuition at Stanford" - MarketWatch, Dec. 30
"Focus on Small Caps in 2015" - Investing.com, Jan 6
"Stock pickers bet on small caps, Apple" - CNBC, Jan. 13
"Small caps to benefit most from US recovery" - The Globe and Mail, Jan. 16

So we have IWM trading beneath stubborn resistance, even as bulls appear to be ramping up their expectations for some kind of redemption narrative in the small-cap space, possibly including -- based on the front-month open interest configuration -- a breakout north of $120 in the short term. Do we have the makings of a bearish contrarian play on the small-cap ETF?

Well, not so fast. In recent months, IWM has established a floor in the $115 region. Since Oct. 31, in fact, IWM has settled outside of the $115-$120 range on only eight occasions. In other words, that's nearly three solid months' worth of a sideways chop within a roughly 5-point range. Not only is the potential reward for capturing a directional move within this channel rather strictly capped, but correctly timing such a trade would be extremely difficult.

In addition, IWM's rising 80-week moving average is now at $112.58, and has been increasing at a rate north of 50 cents per week. This trendline served as support over the course of the sharp pullback in October 2014, as there were just two weekly closes below this moving average, and the retest of 80-week support near the end of the month marked the "all clear" and the beginning of the subsequent IWM rally back to its highs.

Weekly Chart of IWM since April 2013 with 80-Week Moving Average

One of the many advantages of options trading, of course, is the ability to capitalize on virtually any variety of price action, including the otherwise generally frustrating "sideways chop" now being demonstrated for us by IWM. If a trader wanted to profit from a stock's trading range, selling premium would be the way to go -- either by selling to open puts or calls individually, or by combining contracts to create iron condors or other flavors of credit spreads.

Of course, just because there's a strategy in the options universe that aligns with a given stock's price action doesn't necessarily mean you should jump to place the order with your broker. One of the "wild card" factors often overlooked (and at great cost) by novice options traders is implied volatility, which plays a significant role in determining an option's value -- and, by extension, your possible reward on a trade.

In the simplest terms, higher implied volatility is a detriment to premium buyers, but a positive for premium sellers. And when you're selling to open puts and calls, whether on their own or as part of a multi-legged credit spread, you are a net seller of option premium.

Our Senior Equity Analyst Joe Bell, CMT, has quite a bit of experience selling credit spreads, and IWM has been the target of more than one of his trades over the years. By his lights, though, the timing isn't quite right to sell premium on the small-caps. "Implied volatility has come down about 20% off its January highs," he notes. "While $120 continues to be a hurdle for the ETF technically, traders may want to watch for a spike in volatility to set up an entry for any premium selling positions." In the meantime, it would appear that the best IWM trade -- at least for the moment -- is no trade at all.


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What We're Expecting for Stocks in 2015

The key technical levels to watch for the VIX, RUT, XIV, and SPX in the new year

by 12/29/2014 10:42 AM
Stocks quoted in this article:

The following is a reprint of the market commentary from the January 2015 edition of The Option Advisor, published on December 18. For more information or to subscribe to The Option Advisor, click here.

As of this writing, the Fed's promise to be "patient" on interest rates seems to have snapped stocks out of the slump they endured during the first half of December -- suggesting the positive momentum that traditionally carries the S&P 500 Index (SPX) higher into year-end may finally be gaining traction. Of course, for a market that makes 2% moves on the basis of what is, for all intents and purposes, an adjective update by the central bank, there are certainly no guarantees that 2015 will bring us smooth, low-volatility gains.

In my Dec. 7 "Chart of the Week" column, I discussed the significance of the 40 level on the VelocityShares Daily Inverse VIX Short-Term ETN (XIV). During the bulk of 2014, moves above 40 for this "inverse volatility" vehicle have corresponded with positive returns for the S&P, while breaks below this round-number level have been reliable indicators of volatility spikes (and coincident equity sell-offs). Indeed, once again, the XIV rejection at 40 earlier this month coincided with fresh pain for stocks, even as the action in the major equity indices themselves failed to offer any hints of trouble ahead.

In the short term, it will be worth shifting the focus a bit south, and watching XIV's progress as it works its way back up toward 36. This area marked a peak for the exchange-traded note back in January, and then switched roles to provide support in August. Just a couple of months later, a daily close below this level on Oct. 9 signaled an impending volatility spike. As XIV advances, a rejection at 36 could be an effective "canary in the coal mine" for an impending rough patch for stocks.

Daily Chart of XIV since January 2014

Looking beyond XIV, there are several other significant technical levels that should come into play for the major indices in 2015. The latest surge in the CBOE Volatility Index (VIX) topped out around 24, roughly double its November-December lows in the 12 region. Amid this week's bounce in stocks, the VIX quickly pulled back below 20 -- a round number that could continue to act as resistance on rallies, as it's double the index's current annual low of 10.28.

In fact, the VIX has spent most of the past two-and-a-half years sandwiched between 10 and 20. Since mid-June 2012, the index has notched only four weekly closes on the upside of this range, and zero below. Look for these decade levels to continue marking key tops and bottoms in the new year.

As you might expect when a benchmark trades around a major millennium mark, there's been a lot of chatter about S&P 2,000 lately. While it's obviously a nice round number, 2,000 holds some additional significance for the S&P, as this price point represents a near-exact tripling of the index's March 2009 low at 666.79. It wouldn't be surprising to see this area continue to act as a "magnet" for the S&P in the coming months, as these round-number milestones have a tendency to do.

In terms of support, any pullbacks by the S&P could be contained by one of two key long-term trendlines. Its 10-month moving average, located at 1,969.30, has been cushioning the index's dips since June 2012. Meanwhile, the 20-month moving average is at 1,849.20, or roughly 20% above the peaks set by the S&P directly prior to the bear markets that began in 2000 and 2007.

Speaking of "magnetic levels," the small-cap Russell 2000 Index (RUT) has spent a healthy portion of 2014 trying to break free of the gravitational pull of its 2013 close at 1,163.64. On the upside, the 1,200 level has capped rally attempts, and no wonder -- this round-number region represents roughly double RUT's March 2000 peak and October 2011 low, and approximately triple its 2008-2009 lows. It's no mystery, then, that profit-taking tends to overwhelm RUT every time it challenges this region.

As major equity indices attempt to mount sustained breakouts above significant round-number levels, a crucial question becomes: Is there enough buying power left on the sidelines to push stocks higher from here? Surveying a few of our favorite broad-market indicators, we find that total short interest on S&P components has declined 2.2% since the end of 2013, while the number of analyst "buy" ratings on these stocks has increased 1.7 percentage points over the same time frame. Meanwhile, the ratio of bulls in the weekly Investors Intelligence (II) survey has dropped to 49.5% from 61.6%.

So, during a period in which the S&P has gained about 11.5%, and set new record highs in the process, sentiment has increased only marginally at best, and -- in the case of the II survey -- actually deteriorated. While it would be short-sighted to overlook the significance of major round-number "magnets" that could continue to hold sway over stocks in the coming months, it seems fair to observe that we're not yet at the "euphoria" stage of this bull market. Keep an eye on XIV as a possible "tell" for short-term shocks, but look for the major equity indices to ultimately extend their climb up this persistent wall of worry in 2015.


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Why You Need to Watch XIV at 40

How the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) works as a proxy for stocks

by 12/11/2014 1:22 PM
Stocks quoted in this article:

My guess is you are familiar with the appearance of charts of the CBOE Volatility Index (VIX) over the past year or two. "Ugly" would be a common way technical analysts (including this observer) steeped in charts of equities would describe them -- the endless, directionless chop; the declines that inevitably (and usually abruptly) terminate in the 10-12 area; the sharp rallies that seem to end as quickly as they begin (rarely lasting for more than three weeks, give or take).

Of course, there is a very plausible explanation for these VIX chart characteristics, in the sense that in charting a volatility measure we are, by definition, tracking the fluctuations in a mean-reverting series whose "perturbations" are (quite naturally) often quite extreme and simultaneously quite brief. (The fact that volatility behaves in this manner would seem to be a deterrent to the widespread use of volatility derivatives to "protect" portfolios, but that's a separate discussion.)

But the folks at Credit Suisse seem to have created some order out of chaos in designing and structuring their VelocityShares Daily Inverse VIX Short-Term ETN (XIV). This may be due in no small measure to the fact that equity volatility has had a bias to the low side in recent years. When this is superimposed upon the daily adjustments that characterize the calculation of the XIV (and the fact that the XIV -- as an inverse ETN -- increases in price over periods in which the VIX declines), it often translates into upward XIV price movement that can be rather smooth and steady (as illustrated by the XIV rally from February through July 2014, as depicted on the accompanying chart). And such equity-like price action also creates opportunities to identify price levels that may be of particular significance from a volatility perspective, such as the 40 level for XIV on which our chart is focused.

Note how XIV sliced through the 40 level in early June and, after a brief re-test, went on to what was then (and still remains) an all-time high at 47.66 on July 3. And except for a brief period in early August, XIV traded above 40 from early July through most of September. What turned out to be a decent warning signal for trouble ahead (in the form of the mid-October market correction) was the dip by XIV below 40 in late September, followed by an unsuccessful re-test on Oct. 6 (and further confirmed by the close on Oct. 9 below support at 36). To recap: We had a pretty clear indication that XIV -- which moves in the direction opposite that of the VIX -- was breaking down technically. And by straightforward extension, this was therefore an indication that the VIX may have been headed for an upside pop, which by now we all know strongly implied that the market was about to take a hit.

And right here and now, it looks like the XIV is at an inflection point, though none is apparent from the charts of the major equity indices, which have all been registering all-time highs with almost boring regularity. Because after rallying sharply from its low of 24.67 on Oct. 18 (in conjunction with the sharp decline in the VIX and the concurrent sharp rally in equities), the XIV's upside progress over the past week or so has been stalled in the 40 area. In fact, this past Friday was the first trading day since Oct. 6 that the XIV had traded above 40, and after its early peak at 40.74, the XIV barely managed to remain above the 40 level -- closing at 40.07 after dipping as low as 39.70 late in the session.

So -- as I pointed out in the discussion on the XIV chart -- we are at a juncture in which further upside progress by XIV above 40 would be consistent with further upside for the market. But if this assault by XIV on the 40 level is repelled, things could begin to get pretty dicey for the market pretty quickly, especially if we once again dip below XIV support at 36. Would this decline resemble October's crash-like (but thankfully, brief) market plunge? It is impossible to say at this point, and by this I mean anything would be possible -- including a pullback that inflicts greater damage over a longer time frame. But my strong inclination would be that if we are destined for major market damage, this would not occur until after the first of the year.

Daily Chart of XIV since December 2013

This "Chart of the Week" commentary originally appeared in the Dec. 7, 2014 edition of Weekend Player.


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Expect the Best for Stocks (But Buy Puts While They're Cheap)

What's next for the S&P 500 Index (SPX) after a string of new highs?

by 12/1/2014 12:08 PM
Stocks quoted in this article:

The following is a reprint of the market commentary from the December 2014 edition of The Option Advisor, published on November 20. For more information or to subscribe to The Option Advisor, click here.

"May you live in interesting times" goes the old curse -- but please don't take it the wrong way if we observe that it's been an interesting couple of months in the market, to say the least. Both bulls and bears have endured their fair share of jolts, but there have also been some remarkable profit opportunities for longs and shorts alike.

Where to begin with an analysis of the recent action in the S&P 500 Index (SPX)? Well, the Sept. 19 initial public offering (IPO) by Chinese e-commerce giant Alibaba Group (BABA) is a logical place to start, as many pundits predicted the widely hyped IPO would mark a top for the S&P. (A quick Google search for "Alibaba IPO market top" is informative here, yielding north of 5 million results.) In fact, the same day that BABA made its trading debut on the Big Board, the S&P touched a then-record high of 2,019.26.

Of course, as discussed in this space last month, the index proceeded to tumble 9.8%, peak to trough, over the next 18 sessions. While the magnitude of the correction wasn't all that remarkable within the context of a long-term bull market, the sheer speed of the drop sparked panic -- as well as a few victory laps by perma-bears and BABA top-callers.

Those victory laps were a bit premature, though. After bottoming at 1,820.66 on Oct. 15, the S&P spent the final 12 trading days of the month riding the rebound express. The index finished October at a new daily closing high -- and then rang in the month of November by tapping a record intraday peak right out of the gate. For the first time in its history, the S&P went from an all-time high to a six-month low, and then back to an all-time high, in less than two months.

Since then, the S&P has been grinding steadily higher, creating a string of new all-time highs despite a lack of major day-to-day moves. As of this writing, 10-day realized volatility on the S&P stands at 3.03% -- just high enough to confirm the market has a pulse, though the patient appears to have come down with a minor case of exhaustion.

So, where do we go from here? Over a sufficiently long time frame, history tells us that the market will always trend higher -- but, of course, it's the ability to capture the not-quite-so-predictable short-term moves that defines our success as traders. With that in mind, there's good reason to think stocks will continue their steady march higher over the coming weeks.

For starters, there's good old Santa Claus and his reliable rally. The S&P averages a return of 1.5% during the month of December -- second only to April -- and finishes the month higher 74% of the time, going back 50 years. Most of those gains are racked up during the second half of December; the S&P has advanced an average of 1.4% during the last five days of December and the first two days of January (the traditional "Santa Claus rally" period).

Of course, it's fair to theorize that these year-end gains are generated not by St. Nick, but (to a non-trivial extent) by fund managers scrambling to boost their paper performance -- the reliable old "window dressing" tailwind. According to Morningstar data, the average U.S. equity fund was trailing the S&P by more than 5 percentage points, on a year-to-date basis, as of Nov. 19. As fund managers rush to keep pace with the stock market, buying activity by these deep-pocketed players should be a positive catalyst through year-end.

In addition to our regularly scheduled end-of-year programming, it seems the type of "V bottom" the S&P just created may also have bullish implications. Our Senior Quantitative Analyst, Rocky White, ran a study to measure the index's performance following moves similarly dramatic to the one described above. Since 1929, there have been 12 instances where the S&P has touched a 52-week high, pulled back to a two-month low, and -- less than one month after that -- overtook the recent 52-week high again. Following these signals, the S&P has averaged gains that outstrip its "anytime" returns over one-month, three-month, and six-month time frames.

So, while the forecast seems to point to additional upside ahead, the recent S&P whiplash reinforces the notion that it's always wise to expect the best, but prepare for the worst (advice that rings equally true whether you're a perma-bear, perma-bull, or pragmatist). At 13.58, the CBOE Volatility Index (VIX) is currently running at a considerable premium to S&P realized volatility -- but, that said, the VIX is down about 56% from its highs of just over a month ago. As such, now is as good a time as any to pick up portfolio protection, in the form of put options, to both protect your paper profits and guard against any additional shocks over the short term.


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Why the S&P's 200-Day Is Only Part of the Story

The S&P 500's 200-day moving average is just one of the indicators you should be watching

by 11/3/2014 11:26 AM
Stocks quoted in this article:

The following is a reprint of the market commentary from the November 2014 edition of The Option Advisor, published on October 23. For more information or to subscribe to The Option Advisor, click here.

The week of Oct. 13 was a wildly volatile one for stocks. Due to a combination of disappointing economic data, mixed corporate earnings, and fears about the spread of Ebola, the major equity indexes were hit with heavy selling pressure.

In fact, the dramatic market action that week resulted in the highest total number of selling climaxes since Sept. 29, 2011. (A "selling climax" occurs when a stock hits a new 52-week low, but then settles above the previous week's close.) As indicated on the chart below, important market turning points in the recent past have often been accompanied by a huge spike in the total number of these types of climaxes. While it's obviously too soon to make the call -- there was a cluster of multiple selling climaxes in 2011, before the market eventually found its footing -- this could be a sign that we're in the process of capitulation.

SIR All Optionable Selling Climaxes since July 2011

With such dramatic volatility accompanied by a sharp sell-off, did we finally get the infamous 10% correction on the S&P 500 Index (SPX)? Not quite. Based on the index's 2014 intraday high of 2,019.26, and its Oct. 15 intraday low of 1,820.66, we registered a 9.8% pullback. Despite "failing" to reach this benchmark, the S&P did break below its 200-day moving average for the first time since November 2012.

Prior to breaching this widely followed trendline, the S&P had spent 477 consecutive trading days above it -- the third-longest such streak since 1950. As you might imagine, the index's drop below its closely watched 200-day sparked a ripple of panic among market watchers. This surging anxiety was reflected by a nearly three-year high in the CBOE Volatility Index (VIX), which occurred simultaneously with the S&P's 200-day break. (Anecdotally, StockTwits data shows that message volume for VIX spiked dramatically on Oct. 15 and 16, confirming a sudden flurry of interest in the market's "fear gauge.") So while the 200-day breach clearly triggered a wave of fear among investors, does this technical development necessarily suggest more pain and selling is ahead?

If history is any guide, the answer is most likely "no." Since 1950, there have been 13 other streaks similar to the one that just ended, where the S&P spent at least 252 trading days (approximately one year) above its 200-day moving average. The last three times a streak like this ended, the S&P proceeded to collect double-digit returns over the next 12-month period -- ranging from a 45.8% rally following the July 1996 trendline breach, to an 11.5% rise after the July 2004 break.

From a broader view, looking back at all 13 prior occasions when the S&P has breached its 200-day moving average after a long winning streak above it, the index has averaged a gain of nearly 12% over the next 12 months -- besting its average "anytime" one-year return of 8.8% since 1950. In other words, in circumstances in which the index has been firmly entrenched in upside action consistent with a bull market, that first break below the 200-day has typically represented a correction and a buying opportunity, rather than a sell signal.

However, for those traders who may have panicked out of their long positions following the S&P's break below its 200-day trendline, the market's quick and nimble reversal from its recent slump may have come as an unpleasant (and potentially costly) surprise.

On the other hand, if you'd also had the less-popular 320-day moving average -- a trendline we at Schaeffer's have favored for years -- on your trading radar, you would have spent Oct. 15 witnessing a very tidy S&P pullback to this level. While the index briefly dipped below its 320-day in intraday action, this trendline was never breached on a daily closing basis. This test of moving average support was followed in short order by an S&P rebound back above its 200-day, and the index has continued to recover impressively from that bout of wild mid-October volatility.

In light of these developments, it seems safe to affirm our belief that one indicator does not a trading system make. Despite the surge in fear that accompanied the S&P's most recent 200-day breach, the index's past performance suggests that this technical occurrence, when it follows on the heels of a long streak of outperformance, is rarely a reliable sell signal. By viewing day-to-day price swings within the context of longer-term trends, it's possible to keep your head while others around you are losing theirs. And it's worth reiterating that a roughly 10% pullback within the context of a years-long uptrend is, to a certain extent, inevitable -- as bull markets are quite unlikely to take the form of a straight vertical line (even though some of these 10% haircuts may transpire a little faster than the typical trader's constitution can comfortably endure).

Going forward, we recommend that you continue to watch the S&P's 320-day moving average as a key level of support, in order to keep the bigger-picture trend in perspective. And with earnings season, mixed economic data, and shifting monetary policy keeping traders on their toes, our Monday Morning Outlook column will help you stay current with the crucial technical levels we're watching each week.

Daily Chart of SPX since February 2014 with 200-day and 320-day Moving Averages



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  • Founder and CEO of Schaeffer’s Investment Research, Inc. and Senior Editor of the Option Advisor newsletter since 1981
  • Recipient of the Traders’ Library “Trader’s Hall of Fame” award and the Market Technician’s Association “Best of the Best” award.
  • Timer Digest consistently ranks Bernie’s market timing among the top 10 out of more than 100 analysts.
  • Three-time winner of the Wall Street Journal stock picking contest.
  • Bernie is a regular guest on PBS’ Nightly Business Report and Bloomberg Radio and he has made frequent appearances on CNBC.
  • Bernie’s award-winning SchaeffersResearch.com website is the #1 destination for options traders and a top choice for active stock traders.
  • In 2009, Bernie launched Bernie Schaeffer’s SENTIMENT, the only print and electronic magazine for equity options traders.
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