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There was no news of significance today, and European markets led the U.S. into a higher open. That open was almost precisely where we closed, and since the S&P 500 was up around 12 pts at the high, a 6 point advance from open to close formed a shooting star candle. A lot of traders love to call this a bearish reversal or ugly candle, but the data does not support that. Bulkowski’s data demonstrates that it is merely a random probability what follows a shooting star:

http://www.thepatternsite.com/ShootingStar.html

The VIX took the lack of bad news pretty hard as it fell to around 14. Today had the feel of a typical summer session, with low volume and low volatility the characteristics of the day. The VIX term structure steepened and contango widened in the front months of the VIX futures curve:

Meanwhile, this was the trip for the September future. This is the only thing that matters now for VXX and UVXY holders, as it dominates their holdings:

This kind of action in the primary long holding in UVXY did some damage to the UVXY short $100 calls, which of course worked well for subscribers:

The VIX reached July 30th levels:

Our next letter for subscribers will be published tomorrow night. I anticipate a few new trades this week, and we are on quite a roll lately….

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This was the day in the August future:

After the Polish minister news was blamed for the 15 handle S&P dip in 30 minutes yesterday, the DAX opened sharply lower boosting the VIX futures at around 3am. When the SPX bounced early, the VIX fell but as it was yesterday afternoon, selling reemerged to bring the VIX futures to unchanged.

Yet our short UVXY $100 Jan calls fell anyway:

The ECB meets tomorrow under the specter of correcting markets in Europe. Take a look at the DAX, it is now in a 10% correction:

Mario, not unlike Helicopter Ben, is usually good for markets. Already having instituted a negative rate window, now asset purchases are on the table. Should be an interesting day tomorrow.

A couple more interesting charts: the Rut2k is finding a base and is now outperforming the S&P over the last few days, and the IYT Dow Transports are still beelining for the 100 day MA. Incidentally the DOW is only 100 or so points from the 200 day moving average.

Pundits in the financial media are working overtime to explain a natural price action in equities. An old axiom by Jessie Livermore postulated that news follows price and that is what is happening these days, especially when ISM services came in at an all-time high (established in 2008, not a huge hurdle mind you), and S&P 500 corporate earnings are poised to grow 10% year-on-year. So the du jour explanation was an old story about more troops on the Ukrainian border.

So maybe there was a runaway news algo at 1pm today, who really cares? These times are a gift, either for those looking for cheaper stock (re:Warren Buffett et al, he has a record cash horde) or for those looking to sell some expensive volatility premium. I fall into that camp of course, and these days are great.

First some common sense, and then some data. Do you really think Russia wants to invade the Ukraine? Probably not. But if Mexico or Canada were in the midst of a civil war, would the U.S. move some of their otherwise idle troops into a nearby area in case something occurred? Of course.

Secondly, if the Fed raises rates, is that such a bad thing? Ok, maybe the cost to buyback stock gets more expensive, but retirees get to spend more money via their less risky savings/treasuries investment returns, and banks can loan more money as their portfolios are less risky. (At higher rates, loan portfolios can handle more defaults, thus more lending.) Both of those are positive for economic growth, and thus corporate earnings. The financial sector is the S&P’s largest, and they would love to loan at higher rates instead of being a conduit for refis. Look at the KRE, the regional banking ETF, it is down 7% this year and that correlates almost perfectly with the rally in bonds.

So the market is overreacting, right? No, the market has to go down sometimes, that is how money gets extracted from stocks and if you believe the Fed is pumping it up to boost the economy that is a good thing. People forget that outflows have to go somewhere else…

In reality, this is just another seasonal and normal dip/correction, whatever you want to call it. August ranks last in all months for performance on the S&P 500 since 1987. Sometimes market selling leads to more selling, and the technicals are broken in the short term. Look at the SPX:

Looks ugly, but there’s obvious support nearby. Keep in mind that earnings are winding down, and stocks tend to get faded after the earnings season ends. Mid-August historically is stronger than the beginning. Yet, this was a real bright spot today, if you want this correction to end…

The small-cap index, the leader to the downside and the demonstrator of the breadth divergence we have been seeing lately, wanted to go positive today. It certainly appears that the selling in this area is nearly over.

Consider the NYMO, the CPCI, and the percentage of stocks trading below their 20 and 50 day moving averages, and we are probably closer to the end than the beginning of this mini-correction. Take advantage of it while it lasts…

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Today saw four month highs in the VIX, the S&P 500 gauge of implied volatility. Generally, sudden demand for puts and an absence of put sellers generates swift spikes up in the VIX, and today’s demand for puts was at a ratio of 2.6 to 1, with the largest percentage of puts being hit at the asking price.

The punditry is scrambling for an explanation, and Argentinian default is a reach at best. It appeared to me that the dip buyers finally dried up and gravity took over taking out the stops. In reality, today’s not that big of a deal after months of methodically plodding higher.

Let’s look at the VIX, VIX futures, and the VXX for immediate opportunities. First the VIX chart for 2014, demonstrating just how long it has been since the VIX has seen 17:

It certainly appears that the VIX is nearing resistance levels, but the VXST (9 day rolling VIX index) is significantly higher:

Meanwhile the VIX August future, which settles in a little under 3 weeks on August 20^th, is not buying the move:

So you now have a backwardation from the VXST, to the VIX, to the VIX future. This means that S&P 500 implied volatility is highest in the nearest term. The translation of the shape of this curve is that investors are not looking for a prolonged sell-off. They are demanding weekly puts at a higher rate than they are looking for longer-term protection. Who can blame them? Every VIX spike has been a great volatility and premium selling opportunity, and put owners and short sellers have been burned over and over again. It is going to probably take a breach of the 100 day moving average on the SPX to get people thinking that something is really going on other than a buyable dip. Here is a look at the VIX futures term structure:

Courtesy Vixcentral.com

If you’re in the camp that this is just a temporary sell-off, then the VXX and UVXY offer some terrific ways to capitalize quickly on a fade in volatility, and I cover these every week in my subscriber newsletter. These ETFs can be tough to borrow to outright short, since the gig is up on these things as perennial value destroyers. I prefer to use the options as they are frequently mispriced, and that is exacerbated the farther out in time you go.

Today I sold the UVXY $50 September calls for $2.40-2.65. Take a look at the chart of this option:

This option has fallen from $20 to $2.76 in 3 months, and it was only $1 yesterday. For this option to be in the money, the August and September VIX futures (the current UVXY holdings) would have to rise another 30% and remain there until the third week of September. The odds of that are quite slim as the September future would have to sit above 20. VIX futures have failed to sustain that price level for any significant amount of time since the spring of 2012.

You can take a longer-term approach by selling the VXX January $40 call. Again, you would need to see the effect of contango in the VXX disappear for stretches of time for that to happen, along with elevated futures prices. That option was up $1 today, so it wouldn’t be surprising to see that come back out of the price in a short period of time. Look even farther out to January of 2016 if you want to sell some calls and do very little position maintenance.

Of course, shorting these ETFs for the long haul will always work depending on your time frame. It’s only a matter of when, not if, the next reverse split arrives.