High Yield Caution
Friday iShares iBoxx $ High Yield Corporate Bond ETF (HYG) made a noticeable decline and after testing the August 2 high on September 1 it then turned lower. As one of our Foremost Indicators, the failure to continue higher at the previous high deserves some attention. There is more below including a put spread idea, but first a brief market review.
S&P 500 Index (SPX) 2461.43 slipped 15.12 points or -.61% for the week but remained above the 50-day moving average at 2454.90 after declining 18.70 points last Tuesday on geopolitical news from North Korea and then recovering Wednesday to make a small inside range day that began forming a possible symmetrical triangle continuation pattern.
CBOE Volatility Index® (VIX) 12.12 turned higher again gaining 1.99 points or -19.64% for the week while the comparable IVolatility Implied Volatility Index mean, IVXM increased 1.10 points or 15.58%.
Chart Courtesy of StockCharts.com
VIX Futures Premium
The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second month futures contracts.
As the VIX advanced again the premium declined from the top of the range at 30.58% to 15.81% as September futures expiration approaches in 7 days when the futures will equal the VIX.
Friday's Chart:
With 7 trading days until the September expiration, the day-weighted premium between September and October allocated 28 % to September and 72% to October for a positive 15.81% premium.
The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration.
iShares iBoxx $ High Yield Corporate Bond ETF (HYG) 87.79 declined .53 points or -.60% for the week after testing the previous August 2 intraday high of 88.35 on September 1 where it apparently also found resistance from the operative upward sloping trendline, USTL and turned lower.
Chart Courtesy of StockCharts.com
While it could find support at both the 50-day moving average and the and the previous highs shown as the green support line, failure would suggest formation of a possible double top pattern with a downside measuring objective near 85. With both credit and interest rate risk, a trend change should it occur, would be quite negative.
As a hedge against a further decline that may exceed support consider this put spread.
First the options data.
The current Historical Volatility is 4.30 and 2.95 using the Parkinson's range method, with an Implied Volatility Index Mean of 6.20 up from 5.34 the week before. The implied volatility/historical volatility ratio using the range method is 2.10 so option prices are expensive relative to the recent movement of the ETF. Friday’s option volume was 54,810 contracts with the 5-day average of 111,453 contracts and with reasonable bid/ask spreads.
Chart Courtesy of StockCharts.com
IVXM 6.20, HV 4.30, PHV 2.95
Using the ask price for the buy and middle for the sell the debit would be .49 with an attractive implied volatility edge (6.86 for the long option and 8.95 for the short) and about 25% of the distance between the strike prices. Use a close back above 88 as the SU (stop/unwind).
The suggestion above is based on the ask price for the buy and middle for the sell presuming some price improvement is possible. Monday option prices will be somewhat different due to the time decay over the weekend and any price change.
Geopolitical news derailed the S&P 500 Index last week as it attempted to retest the previous high while options implied volatility remained high and appears trending higher. Since September is historically a seasonally weak month along with HYG turning lower it may be time to consider hedging long positions.
Summary
So far the S&P 500 Index has been unable to recover from concerning geopolitical news early last week and showing signs of indecision while the VIX trends higher. Then when credit sensitive HYG turned lower the yellow caution light began flashing just enough to begin considering hedging or at least reducing long exposure since "Buy the Dip" appears stalled for now.
Disclaimer: IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter ...
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