From the Top

Tracking Year-to-Date Returns for Stocks and Precious Metals

Why traders should keep an eye on the SPDR S&P 500 ETF Trust (SPY)

by 3/10/2014 9:18 AM
Stocks quoted in this article:

The following is a reprint of the market commentary from the March 2014 edition of The Option Advisor, published on Feb. 27. For more information or to subscribe to The Option Advisor, click here.

I've pointed out on many occasions in this space the importance of tracking year-to-date percentage changes for market indices, sectors, and individual stocks, as various levels of round-number gains (or losses) on a year-to-date basis have proven their value time and again as markers for support and resistance.

The first of our two accompanying charts (click to enlarge) compares the year-to-date performance of the Dow Jones Industrial Average (DJIA) with that for the 3 major index ETFs -- the SPDR S&P 500 ETF Trust (SPY), iShares Russell 2000 Index ETF (IWM), and PowerShares QQQ Trust (QQQ).

DJIA in 2014 with SPY, IWM, QQQ

Note how this cluster of barometers of the health of the U.S. stock market collectively failed to move convincingly into positive territory on a mild market rally in mid-January, which then set the market up for its unpleasant pullback into the end of the month.

But there was greater differentiation as this pullback played out, as only the DJIA fell significantly below the negative 5% mark, while the QQQ held at the negative 4% level. And this disparity has continued to play out on the subsequent rally, with the DJIA still ensconced in negative year-to-date territory, QQQ and IWM now a couple of percentage points to the good, and SPY (representing the largest-cap names) now moving into a positive year-to-date position this week for the first time this year.

I'd suggest you pay particular attention to the year-to-date levels for SPY and the associated S&P 500 Index (SPX) in the days and weeks ahead, because if this week's breakout into positive year-to-date territory is "for real," we could see some significant upside follow-through, with perhaps a quick 10% rally for "openers." But if the move by the S&P into the "green" for 2014 is short-lived and soon rejected, the subsequent pullback could be sharp and scary. (SPY closed 2013 at $184.69; SPX at 1,848.36 -- you can compare their current values to these benchmarks to determine if they are positive or negative for 2014.)

While the year-to-date picture for the U.S. equity market is one of struggle and resistance, our second year-to-date chart (click to enlarge) presents quite the opposite picture for the precious metals ETFs -- the Market Vectors Gold Miners ETF (GDX), SPDR Gold Trust ETF (GLD), and iShares Silver Trust (SLV).

GLD has never been in negative territory on a closing basis in 2014, though it struggled for the past week or so before it took out the +10% level. And note the support at the zero line that emerged for SLV on its late-January pullback, with the subsequent rally then breaking through +10% before weakening. But I find the remarkably strong GDX action (representing the gold mining shares) to be most instructive of all -- first supported at the zero line just after the first of the year, then a struggle at the +10% year-to-date level, and finally a sharp rally that first hurdled a speed bump at +20% and then another at +25% before GDX settled into its current position of bouncing between the +20% and +25% year-to-date levels.

DJIA in 2014 with GDX, GLD, SLV

Those who trade these precious metals ETFs should be keeping a close watch on the ongoing battle by GLD and SLV to hurdle the +10% year-to-date line once and for all, as success or failure at +10% could prove a major indicator for whether the remarkable 2014 gains across this sector will undergo a further build, or whether consolidation is in order.

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Why I'm Watching XIV at $30

Two ways today's pullback in the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) could play out

by 3/3/2014 12:28 PM
Stocks quoted in this article:

The VelocityShares Daily Inverse VIX Short-Term ETN (XIV) dipped to about a point below the key $30 level earlier this morning before beach-balling back above by a few pennies. Meanwhile, today's volume is running about three times the normal level.

XIV pullbacks on big volume to round-number levels have been good market-bottom indicators over the past couple of years. Even better has been when the ETN's 14-day Relative Strength Index (RSI) was touching 30.

In January, there was a "fake out" hold at $30 and then a final plunge in early February to just below $26. The big volume was there for a hold at $30, but the 14-day RSI was still well off 30, and it took that final XIV plunge for the RSI to get there.

The current situation can go either of these two ways. One possibility could be that $30 holds by the end of today and volume remains high, and the pullback (in both XIV and the broader equities market) is over. The fact that this was a geopolitical-based pullback on a Monday morning after an expiration could add up to a situation ripe for semi-panic lows being in place not long after the opening -- in other words, just a storm passing through.

Mitigating against the XIV-bottom argument is the fact that the market is coming off multiple tests of the usual resistance (the recent action of the S&P 500 relative to 1,850 and its 0% year-to-date level was not too different from that in January, before the pullback), and one could argue it's questionable for a pullback to be completed in one morning under those circumstances. Perhaps related to this is the current XIV 14-day RSI level of 42, which could set up a need (assuming $30 is broken) for a test of last month's XIV lows before XIV is sufficiently oversold to strongly indicate a bottom.

I think a lot may be riding on whether XIV can hold above $30 -- today and in the days immediately ahead.

XIV 30 and RSI 30

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A Lesson Learned from the VIX Options Pits

Has VIX trading logic turned on its head?

by 2/3/2014 12:29 PM
Stocks quoted in this article:

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

"A lot of people are getting ready for higher volatility..."
--Ryan Detrick, CMT, Senior Technical Strategist at Schaeffer's Investment Research, as quoted by Bloomberg and in the 1/18/14 edition of our Monday Morning Outlook

"Meanwhile, in the [CBOE Volatility Index] pit, paper sold Feb 13 puts to buy Feb 16 - 20 call spreads on the index, paying 14 cents, 110000X."
--Fred Ruffy, Trade-Alert, 1/9/14

At Schaeffer's Investment Research, much of the service we provide investors involves recommending specific trades on individual stocks involving the purchase of call options or put options (and, in the case of our much-revered Volatility Trader service, the purchase of call options AND put options in the form of a straddle trade).

And the backdrop for these options trades -- in terms of the general level of their "pay to play" price (also known as "implied volatility" in the options market) -- has rarely been more attractive.

For example, using the level of option premium as described by the 30-day implied volatility of options on the PowerShares QQQ Trust (QQQ) as a proxy for the cost to play equity call or put options, per the accompanying chart, this QQQ implied volatility has ranged over the past two years from a high of about 27% to a low of 11%, with current levels at about 13%. And since the level of implied volatility correlates just about directly with the premium levels for at-the-money options, it is fair to say that the breakeven hurdle for option buyers has rarely been more modest, and the leverage achieved by option buyers relative to the movement in the underlying stocks has rarely been higher.

30-day at-the-money implied volatility for the PowerShares QQQ Trust

So it makes perfect sense for intelligent speculators these days to be buying calls and puts in the current environment as a preferred means for capturing the price movement of stocks on which they have a strong directional view over defined time periods.

So far so good -- but when I take a closer look at what seems to be the ongoing trend in how those who trade options on the CBOE Volatility Index (VIX) go about their activities, logic seems to be turned on its head. And I'm thinking there may be a valuable lesson in this for all of us.

It is likely you are familiar with the VIX options. For one thing, the VIX options have consistently led all other option classes in trading volume for quite some time. And for another, those who buy VIX calls are betting on an increase in equity market volatility -- a bet that has been as extreme in its popularity in recent years as it has been unsuccessful in its outcome for those who've chosen to participate.

So with this in mind, let's simplify a bit what Fred Ruffy of Trade-Alert reported on Jan. 9 as headlined above, and say that a trader purchased a huge block of VIX February 16 calls , but he/she also sold the same quantity of VIX February 20 calls to create a bullish call spread. And if you are familiar with the dynamics of bullish call spreads, you know there are two major takeaways from this strategy:

  1. By selling the further out-of-the-money option, your cost for entering the position is reduced.

  2. By selling the further out-of-the-money option, your profit potential for the trade is not theoretically unlimited as would be the case if you had purchased a plain vanilla call option, but it is instead truncated, because you have in effect sold away all the gain potential above the strike price of the further out-of the-money option.

So why -- in the wake of my preamble singing the very real virtues of plain vanilla option buying in January 2014 -- are VIX players instead buying bullish call spreads and truncating their profit potential?

The short answer is because volatility-based options are quite the different animal from price movement-based options, and in fact, volatility-based options are not so very cheap. But I much prefer the comments of my colleague, Todd Salamone, when it comes to assessing the motives of these VIX options traders:

"I see this type of (bullish call) spread in the VIX pits daily, and the popularity of this strategy reflects what I heard at the Options Industry Conference a couple years ago. Portfolio managers began whining about the cost of 'portfolio protection' programs (consisting of expensive VIX call options that regularly expired worthless). I think option strategists at brokerage firms have heard the portfolio managers to the point they've developed strategies (such as the bullish call spread) that I liken to protecting only the kitchen and risking the entire house burning down."

And to what does that great turn of phrase -- "protecting only the kitchen and risking the entire house burning down" -- translate in our world of options trading?

When you are buying VIX calls to help protect your stock portfolio in the event of a stock market crash -- during which the VIX may soar to 90, or 100, or even higher as investor fear turns to outright panic -- you may not want to readily cap your profits on your protection trade to the 20 area on the VIX. Or (as would be much more applicable to the vast majority of individual option traders), when equity option premium is priced at its current very reasonable level, you don't want to sell a further out-of-the-money option against an option you've purchased and thereby grant to another party all that sweet price movement that might occur beyond the strike price you've sold -- all in the interest of saving a couple of bucks at the outset.

Do you believe the stock you've been so closely tracking is ready to make an outsized move in a few weeks (or a perhaps few months)? Then consider buying a call (or a put), but make sure you buy enough time. But if your conviction isn't there, then don't torture out an options strategy to allegedly accommodate your lukewarm view. Save your money and wait for a legitimate opportunity for potentially multiplying it.

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Twitter Inc (TWTR): A Remarkable Situation

Dissecting the post-IPO price action and options activity in Twitter Inc

by 1/6/2014 8:14 AM
Stocks quoted in this article:

The following is a reprint of the market commentary from the January 2014 edition of The Option Advisor, published on Dec. 26. For more information or to subscribe to The Option Advisor, click here.

"Remarkable" is an adjective I try to reserve (particularly regarding its use in my descriptions of stock market phenomena) for unusual circumstances that might also teach us a thing or two. And by more than one standard, the post-IPO action in Twitter (TWTR - $73.31) -- in its share price and its option activity, and also in the sentiment backdrop it has evoked -- has been quite remarkable.

To wit:

  • A 22% share price decline within weeks of its IPO-day peak at $50.09

  • A relentless 92% rally from its post-IPO low ($38.80) to today's high ($74.73)

  • A level of investor skepticism that, in this observer's opinion, makes the throng of analysts who panned Google (GOOG) before and after its IPO in the summer of 2005 appear to be blowing kisses at the "Google twins."

In fact, this TWTR sentiment backdrop deserves a few bullet points of its own before moving on to the remarkable world of TWTR options.

  • A national business and financial weekly identified Twitter as a "bubble" on the cover of an issue published more than 3 months before the IPO.

  • The average analyst price target among the 20 or so who cover TWTR is (as of this moment) $43.

  • In a December 16 Wall Street Journal article, it was reported that of the 24 analysts who cover TWTR, 16 currently had "hold" or "sell" ratings; the piece also cited "the skeptical chirping from some of the Wall Street firms that took the company public."

And in the world of Twitter options, we have the following "fun facts":

  • 904,000 contracts in total option volume today, with 618,000 of this volume on the call side (stay tuned)

  • Total option open interest approaching 1 million contracts

  • But perhaps most remarkable of all is the Twitter options phenomenon illustrated on the accompanying chart (courtesy of Trade-Alert); namely, that the daily fluctuations in 30-day, at-the-money implied volatility (IV) for TWTR options moved in the opposite direction from the pattern that would be described in the Equity Options 101 Guide for Idiots and Dummies, which informs us (with ample documentation) that equity option IV increases (often sharply) on share price weakness and IV decreases (usually gradually) on share price strength. And I'll shortly venture an educated guess for the "whys" of this.

But for the moment, let's take a look at the chart (click to enlarge), which sets forth a daily comparison of the TWTR share price (red line) and TWTR 30-day, at-the-money implied volatility (blue line). This chart calls out six specific TWTR price levels (P(n)) and accompanying IV levels (V(n)), with the first point occurring on IPO day and the last today. And what amazes me is how TWTR IV has tracked the share price action directly instead of tracking it inversely as "the book" would tell us.

Daily Twitter Inc (TWTR) contract volume since November 2013

Note that TWTR declines from its peak at $50.09 on IPO day (closing prices are shown on the chart, but in this case we also show the IPO day high) to a low close of $39.06 on 11/25; meanwhile, IV declines from 52.9% to 44.8%. IV then remains flattish as the stock steadily rallies by 10%+, but then IV pops by about 9 points and moves back above 60% on the 12/13 rally and (after a brief pullback in IV along with the stock a few days later) IV then surges to (I have to say it) the amazing level of 113% at today's close.

A possible explanation (which might also account for the explosion in TWTR call volume today) lies with the shorts -- those who engage in betting that share prices will decline and who have served in recent years to deprive hedge funds of bull market performance in a bull market. It strikes me that the shorts (their current TWTR position amounts to 23 million shares -- about 8% of the TWTR share float) were way too complacent in the days after the IPO, and had not done much in the way of buying calls to protect their negative bets on the stock from becoming savaged on a sharp rally. But then, at some point of "critical mass," the TWTR shorts became concerned (on their way to becoming panicked) and decided they'd better start buying TWTR calls in quantity. Unfortunately (for them), they continued to lag in their call hedges and needed to keep playing catch-up until today's climactic (perhaps) pop in TWTR call volume and IV. Put another way, the movement in TWTR IV (up and down) since the IPO has been determined mostly by demand from shorts for protective calls, with the shorts most complacent (where else?) at the share price bottom.

And all that call buying to hedge short positions? It served to translate directly into demand for TWTR stock, so the more the shorts belatedly "protected" themselves, the more their positions were in the hole.

So does today's feeding frenzy in TWTR calls mark a top for the stock? And does this less-than-flattering discussion of the activities of the shorts mark a turning point in their fortunes? Buy hedge funds in 2014? Stay tuned.

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Cheap Options, Cover Stories, and the Contrarian Mindset

Reviewing two important contrarian investing principles

by 12/3/2013 11:11 AM
Stocks quoted in this article:

The following is a reprint of the market commentary from the December edition of The Option Advisor, published on Nov. 21. For more information or to subscribe to The Option Advisor, click here.

I don't often focus on three-month rolling returns (I tend to focus on full quarters and "quarters to date" and reserve my "rolling" periods to year-over-year returns). But for "laughs and giggles" (my explanation -- others may accuse me of not having enough of a life outside the stock market), by way of the impressive screening capabilities at, I took a look at the top and bottom performers for the past quarter and found some interesting situations.

At the top of the list of quarterly gains (at 91%) was Nokia (NOK), and I was immediately reminded that: 1. We have an open long recommendation in Nokia January calls in our Options Under $5 service, and 2. I had recently reviewed the premium levels for Nokia options, and my conclusion was they were very cheap, indeed.

This led me to produce the accompanying chart for this space (courtesy of TradeMonster, click to enlarge). And this chart is as strong an illustration as I could imagine providing you of how sometimes the options market can digest input in the form of strong price action accompanied by a pretty high level of volatility, and deliver output consisting of a big yawn (with this yawn being in the form of low implied volatilities, which translates to "These options are sure cheap!"). The story is laid out pretty clearly on the chart, but an even shorter summary is: "You can buy NOK options at premium levels last seen back in August, before the Microsoft (MSFT) deal and while the shares had been languishing for over a year in a $3-$5 trading range."

Daily chart of Nokia (NOK) since May 2013

Does this mean you should now go out and buy NOK calls? The answer is not much different than would be my answer to any question of this nature. You should buy Nokia calls if you feel you have a credible upside forecast for the stock that will play out over the life of your call option in such a manner that the profits you'd achieve on your calls (if you were correct) would result in the trade being worth the risk associated with less favorable share price outcomes. But there is a difference in the case of Nokia (at least as I write this), and this difference can be far from trivial. Namely, the bar for achieving profits on your calls has been lowered because NOK options are cheap. Put another way, at every share price level (assuming a substantial rally in Nokia over your holding period), the profits on your calls will be higher than they would otherwise have been if the calls had been priced at higher levels of implied volatility. Unlike some option traders, I don't reject the idea of buying "rich" options when I feel my price forecast is aggressive enough and compelling enough. But our lives as traders are sure made a lot easier when we are trading a "platinum quality" price forecast and at the same time buying "two-bit" option premium.

And while on the subject of noteworthy quarterly performance, was it simply a coincidence that I had become aware that Fortune magazine had conferred on Elon Musk of Tesla Motors (TSLA) the designation of "Businessperson of the Year" within hours of checking out the bottom performers for the most recent quarter on that same screen? I don't want to make too much of the fact that TSLA posted a 24.5% loss for this quarterly period, what with the fact that the year-to-date gain in the shares is still an eye-catching 260%.

But this quarter- vs. year-to-date performance dichotomy did remind me of a couple of important principles related to contrarian investing as it might particularly relate to major media articles. 1. A high-profile cover story is usually months in the making. In other words, the decision to bestow this honor on Mr. Musk may well have been made at or near Tesla's actual share price peak. Which illustrates the principle that the draw of a stock that has "gone parabolic" (especially if there is a media-friendly story associated with it) is just about irresistible, at the same time as the chances the stock is in the process of putting in a major top are very great. And 2. When a positive media article (in particular, a "cover story," though this concept has been losing some meaning as such information is most frequently being accessed electronically) appears AFTER a stock is down substantially from its highs (preferably six months or longer after such a top), the bearish contrarian implications are compounded.

My favorite example of such a belated situation was a bullish cover story on AOL Time Warner that appeared in a prominent financial weekly a couple of years after that disastrous merger -- the one that kept playing "Can you top this?" on the disaster front until it finally was ignominiously disbanded. Needless to say, the biggest leg of the plunge in AOL Time Warner shares was to be reserved for the period after this belated bullish article. (I also recall at the time that the Wall Street analyst community had still barely budged in terms of taking this company off their "buy" lists.)

Why are such belated bullish media pieces -- written long after a highly favored stock has topped -- such good bearish contrarian fodder? Because in theory, by that time we should no longer be blinded by the skyrocketing share price when attempting to objectively assess the company's prospects. But this also takes us to another topic (too far afield for detailed discussion today) that goes to the heart of what I see as the fatal flaw of so-called "pure fundamental analysis." A hint regarding this fatal flaw? Actually, if you've ever heard an analyst explain that a stock currently trading at 30% or 40% off its high (at which level his firm had rated the stock a "buy") is now "an even better buy based on valuation," you probably have a good sense for the flaw.

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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.
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  • Three-time winner of the Wall Street Journal stock picking contest.
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