The Dow and S&P touched their record intraday highs and reversed course today as bids were hit constantly between 3 and 4 pm. The Dow fell 140 points from the high and the S&P fell 12 points from its high into the close. Today was eerily similar to the May 22nd reversal that ended up being the top for six weeks. The VIX futures couldn’t have cared less:

With the VIX sitting at 13.45, this is a very narrow spread to spot VIX. It is not unique this year for the front month to be this low and the spread to be this narrow, but it is unique that this is occurring with 3 weeks to expiration. The futures are sending a message that the VIX is going to 12 or lower without any premium for unforeseen event risk. It is a very loud all-clear signal. Is this message correct? Who knows, but the futures are charting a new course here.

All year, even as the futures fell toward VIX closer to expiration, they maintained a larger spread than .50. Here is one recent example:

This was only a week to expiration, and the spread was much wider with the VIX at lower levels! This has been the pattern every time the VIX fell to this level. But the market Payday Loan action today as a reversal hammer was put on the chart did not impress anyone in vol land. It will take much more to get their attention. A convincing break below 1675 perhaps, the range for over two weeks.

Implied volatility in the VXX has plummeted. At the money call IV’s are in the 30’s. Amazing. It’s far from rare to see IV between 80-100 on the VXX. The actual value of the VXX is 9 cents lower than the closing price, just something to be aware of if you are putting a position on. The ticker on Yahoo is ^VXX-IV. Anyone should know where this stands at all times, as this is the NAV of the futures in the VXX.

What to do then? The VIX last August fell into the 13’s but the futures fell below 15 only at expiration. This is a new paradigm. The only expectation in the market right now is for lower volatility. This is while the VIX rolls into September:

VIX Volatility Index values generated at:  07/31/2013 15:14:58

Do you really think that heading into September the VIX will be 13? I don’t. At some point the futures will stop falling. The problem to solve is when to get long volatility. I’m not inclined to get long volatility right now, outside of the aforementioned calendars which really are a theta play first.  In fact every little pop in vol has been a boon for VXX put buyers. Today they made a fortune, again.

Just for reference, not that it will matter in these POMO times, August is one of the worst months for stocks historically, #10 Dow, #9 S&P, and September is #12.

Watching the last two weeks, one might certainly get the impression that August will be a snoozer. Especially after the last two weeks have seen virtually no movement on any front. (outside of individual earnings-driven names) The S&P is virtually unchanged from July 15th and is trading in tight ranges. Volatility is quite subdued and the VXX has remained flat over the last week, as the spot to August premium has dwindled, while still having over three weeks to expiration of the August contract.

If there is going to be any volatility in this opex cycle, it should be soon. The small caps are rolling over (IWM MACD cross to the downside), the transports (IYT) are looking to retest its 50 day, and the SPY is looking to cross over as well. There are numerous signs of weakness, but with trading so light it may not matter.  Let’s take a look at the Volatility Wave for August:

We are on day 6 here, and the pattern for volatility shows a tendency for vol to rise beginning this week after doing nothing in the first week, which is very typical for the first week in most cycles. Clearly, any volatility will hinge on the FED, the constantly over-hyped and very misunderstood jobs number on Friday, and the GDP print on Wednesday. GDP is expected to be terrible, so a bad number probably will have no effect. A very good jobs number or FED language could restart the taper hysteria, but it certainly seems that most of those shocks have already been felt, and could be muted.

The futures will probably hold up for a bit, as September is notorious for negative action and August premium to spot VIX is around 1 with 3+ weeks to go. So outside of roll (roughly 5 cents per day) there is not a lot of downside to the VXX, as we have been suggesting over the last few posts. Keep in mind that the VIX itself is rolling into September, so it will probably not fall to the 11-12 area. Spike risk has reduced a bit, solely due to the fact that September now represents a larger portion of the VXX, soon to be over 40% in the next couple days.

There aren’t many trades in the VXX right now that have a distinct advantage from a risk/reward perspective. Buying calls is a waste generally, but selling them in verticals is not offering a favorable trade either. Here is one of the few ideas that will work if the week is uneventful:

Short VXX August 2nd 15.50 for .42

Long VXX August 9th for .62

This calendar works best if the VXX just sits here and rolls. Then on Friday you will be left with the August 9 calls which will be worth .40+ and you only spend .20. The risk on this trade is less than the .20 you are putting up as the deltas are roughly similar. Not much can go wrong on this trade. A spike in vol is covered with nearly equal delta, and falling VXX will leave you with more than .20 at the end of the week. I will probably put this on tomorrow.

Here are the IWM and IYT bearish set-ups. I went long a small IWM weekly 104/103.5 put spread for .25 that will pay 2-1 if the IWM closes below 103.5 this week.

The end of the OPEX cycle and the beginning of the following one frequently demonstrate the lowest levels of volatility for the cycle. As the market has moved completely unabated to higher levels, the VIX has receded to levels reminiscent of the mid 2000’s. It has only spent 3 days below 12 in 2013, and these levels have preceded significantly higher volatility. I suppose that the summer could see a continuous run higher in the S&P every single day, but the odds would be against that.

On April 15th, the VIX rose from 12.06 to 17.27. While I certainly am not suggesting that will happen, one must be aware of the possibilities when the VIX is this low. Because this level of volatility generally precedes higher vol and not more of the same, it behooves one to look for ways to anticipate what most folks are not right now. One month ago, volatility was “here to stay”, and it was obvious that it was not. Now low vol is expected by the punditry with no hiccups in the market until September, because their memory is about a week long, unless the pundit is a perma-bear expecting the next trip to S&P 666.

The futures:

The spread of August to spot VIX is over two, but keep in mind that the VIX futures have an extra week this month, expiring on August 20th, after OPEX. This will hold up that front month premium a bit longer. But it must be noted, that the VXX holds 85% of the front month right now, so if there is action in the marketplace, the VXX can move quickly, without the next month’s extra premium to buffer the rise in the VIX.

I expected a flat to higher VXX over the next OPEX cycle, and that there could be volatility as early as this week. There are no signs of that yet, but if July contains no downside volatility, the S&P will register the largest monthly advance since a 10% bounce in October of 2011 following the debt debacle crash. So in essence, this would be the largest monthly gain in the S&P 500 since 2010 that didn’t follow a major correction. So instead of sending me emails about how I have been wrong for the past whole 3 days, look at this chart and make some of your own assessments:

VIX Volatility Index values generated at:  07/22/2013 14:58:02

The VIX term structure is very low, considering the history of the market in September and October. At the money September SPY puts can be purchased for 2.2% of the current index price. Some very attractive spreads can be constructed at these prices.

Oil reversed and closed lower than the prior day’s low on unchanged volatility. That is very interesting, considering this was the first time since June 21st that this occurred. The put/call ratio was 2 to 1 in the USO, the basis for the OVX, or the oil VIX. The implied vol sits in the bottom third of its 52 week IV percentile, and that is at these lofty levels. I continue to believe that the puts on the USO and UCO remain bargain priced right here. Long UCO $34, $33, and $31 August puts.

I also initiated a long SPY put spread, August 2nd $169/167 for .57. Could return nearly 4-1 if the SPY closes below 167 on August 2nd. Nice asymmetric risk/reward set-up. I do not own any VXX calls (I almost never do), but am eyeing call spreads. I firmly believe that selling call spreads and buying puts when the VIX is high is the easiest way to play the VXX, but occasionally call spreads can present higher probability 2.5-1 risk/reward ratios. One example may be the Aug 2nd $15/15.5 for around .20.

Remember all those technicians with the most famous 50 day moving average of recent times? All those experts that said volatility was “here to stay” for a choppy summer. And those bond kings, that said 2.5% wouldn’t happen this year? Wrong, wrong, and wrong. Being on CNBC or running a $100B bond portfolio does not come with a crystal ball, and so here we are at new highs in stocks.

It seemed like a fairly easy contrarian play, with everybody in the world talking about the 50 day that we would move above it. While I was positioned for lower volatility, I was caught off guard by the size of the move in the S&P and was forced to roll out and up our S&P call spreads.

This year has been a textbook year for stocks in their behavior seasonally, so let’s look at what’s ahead, from a historical standpoint. July is the best month of the summer in the third quarter, #4 for the Dow, #6 for the S&P. July is very bullish in the first half, and as I have pointed out with the volatility wave in prior posts, this right here is the trough historically for vol in the July cycle. The second half of July and the first part of August have demonstrated weaker performance.

As I mentioned yesterday, the crowd is now feeling like we are headed to the moon, and that may be so, but I feel as if we will see higher volatility at some point in the next three weeks, and I chose late next week and the following week as a raw guess as to when that will happen. But while we wait, there are high percentage plays to be made that will work with flat or higher vol. The VIX futures:

The VIX was as low as 13.5 before it finished almost unchanged. The futures are still catching up to it, and July has 3 trading days remaining. This means that the VXX will move up or down primarily on the August futures, which have a reasonable spread to spot being that spot is so low. That will act as a bit of an upside shock absorber. Furthermore, one should not expect significant deterioration in the VXX as we have seen recently due to this structure. The roll is still around 9 cents per day for 3 more days. Then it will be rolling into September at a lower negative yield.

Now, here is where it gets interesting. September is notorious for market sell-offs, but just like May, sometimes it gives everyone a head fake early, gets over zealous shorts covering, and then the selling comes in October. This occurred last year. But, due to this anticipation, the September VIX futures can hold a bid and the curve can get steep.

The other big consideration is the fact that the VIX futures have another week to expiration in the August cycle. That means that the roll has 5 extra days and that the premium to spot will hold on longer. These two factors, the September bid and the August cycle length can hold up the VXX for a long time and prevent decay. So, there is not a ton of downside to the VXX, it may not fall much for quite some time, only having a smaller roll yield to hurt it.

That means that making money on it is still easy. Sell put spreads. Since we can’t make the easiest money selling elevated IV in call spreads during a sell-off, we have to take the opposite approach, and thankfully the VIX is not in no man’s land, like 16-18. It is low enough to take advantage of the VXX on the other end of the option spectrum.

I am trying to time this, so I held off today. I will start one tomorrow and add Monday depending on how the market handles a potentially damaging China GDP number. (Not that the market cares about the global economy or light revenues right now, it could care less.)  What you might see is a low in the VXX around mid-day and then put buyers in the S&P coming in Friday afternoon ahead of next week’s plethora of market moving events.

Specifically I am looking at selling a spread next week and the week after starting at 17. The July 26 puts have 4.4% of downside priced into the VXX, and that will be tough even if the market does not see a down day between now and then. And if that happens, it is easy to roll it down. I like the risk/reward set-up, it is in your favor.

Oil volatility fell 6% today as oil fell. Funny how that happens. This literally means that the call option volatility deflated quickly as it reversed course, the opposite of S&P VIX behavior. The OVX or oil VIX is based on USO options using the S&P VIX methodology. I expect flat to lower oil from here over the next month, and as I posted and tweeted, I am short UCO call spreads and long August puts.

BTW, the NYMO is showing the highest short-term overbought level since June 2012:

These are the days that option sellers love. Nothing happened. Theta burn on higher volatility options and weeklies took its toll on those long options and volatility. One who holds an option is not only long a portion of the underlying, but he is also long volatility and short theta. Not a good day for most of those folks. For those that follow me on twitter, it is has been pretty clear that I have been primarily a seller of vol and spreads over the past couple weeks, considering where we are in the cycle and where we are in the market.

I am always on the search for inflated volatility to sell, but right now what is on my mind is getting long some volatility, as I anticipate something to occur in the next few weeks. The summer is not going to be a slow grind up until September; the odds of that happening are rather small.

So, the futures:

Four trading days left for July and 24 for August. That means that the VXX is moving on August now and as you can see there is still 2.20 of premium to spot VIX which will buffer any up moves in the VIX provided they are blips and not 25 point S&P waterfalls. A 10% move higher in the VIX is nothing at low levels so this buffer is not the same as it was two weeks ago with the VIX at 17 and the front month futures at 19 and 20. There’s a lot more money tied up in puts at those levels.

Index puts to calls are relatively low right now:

Yet the XLF has been seeing some heavy put action the last two days. Yesterday was an astonishing 23-1 put/call ratio:

Today it was 8-1 and while yesterday the majority were bearish put spreads, today the popular opening position were naked puts on the ask for August, very bearish. But, as a caveat, I have mentioned before that these ETF’s have become a hedging tool. They are less costly than VIX options and let you be sector specific. The IV on these puts ranged from 19.5 – 25.

I have a suspicion that sometime between next week and the end of the month we could see rising volatility. I think that selling end of month put spreads in the VXX from 17 lower might be a nice play right here. The S&P is up 3% this month already, and there is a lot noise coming down the pike, starting with China GDP on Sunday night. This should be fascinating as the export print last night was the worst since October of 2009. A plethora of flat top-line corporate earnings and interesting guidance to follow that and big economic data points as well. Gasoline is rising fast and the oil economic choke collar is engaging.

This is not a bearish take, just a suggestion that we are now becoming vulnerable to more vol. My guess, and I stress guess, is late OPEX week or the week after. My crystal ball is on the blink, so don’t blame me if we go straight to 1700 from here.

Oil vol is rising:

And with good reason. The prices are getting frothy up here. I am short UCO July call spreads and long August puts. I am eagerly awaiting the commitment of trader report on Friday to see if the managers are more than the 10-1 long than they were on July 2nd.

Update on other open positions:

VXX short call spread July 12th $20.5 – 22.5 is toast for .40 profit.

SPY short call spread July 12th $166-168 is in limbo at .36, sold for .32. It sits right on resistance with two days to go. I still like it here, and I may add to it tomorrow.

New position tweeted today:

Short IYT July 19th $115-117 call spread for .54. Oil and the transports surging higher yesterday? One has to go down.

Considering these short call spreads:

SODA for July 19th – broken chart

YELP for July 19th – rest period

GMCR for July 19th – gap magnet

Still trying to find a weekly calendar spread in the financials that I like.

Follow @VolatilityWiz on twitter and stocktwits for real-time trading ideas. A subscription service is in the offing; if you are interested in receiving information on this in the near future, shoot me an email using the contact link above.

As usual, if you watch CNBC or read the financial press, you were told that volatility was “here to stay”. Of course, it was not and the VXX is the perfect vehicle for taking advantage of periodic spikes in volatility. I can honestly say, that if I didn’t have to fulfill personal obligations out of town on Friday, I would have ridden it lower, but let’s be real. 100% and 50% gains over a few days are not to be sneezed at, especially when you’re in a position where it is tough to lose, and that is what the VXX provides you when the futures get out of whack with reality.

The VIX is more a reflection of past volatility than future volatility most of the time, and that is a point that most people do not understand. The VIX also has predictable patterns, and July could not have played out history any better. Remember this chart?

This is our proprietary volatility wave, a predictor of monthly volatility. It is far from perfect, but it is a very useful tool. This is day 10, and as you can see, we are near the volatility trough for the month. The question is, what is there to do now?

The VXX can certainly fall further in the near-term, but let’s look at the futures term structure:

The VXX is holding almost 25% July and 75% August, as the VIX futures expire next Tuesday. Therefore, the majority of the VXX move is reliant upon the August contract for the next few weeks. VXX contango is heavy at 8.7% or roughly 8 cents per day. If you want to get long VXX, you probably want to see the the August future fall to 16 or below to have a fighting chance Pokies. Buying calendar call spreads selling the $18 this week and next against the July 26th may get you a free rider on some calls if vol remains low until July 20th. I am eyeing this as a potential trade.

Oil volatility is relatively high, so put spreads on UCO forJuly/August are compelling ideas. A $32 calendar put spread is roughly .75, and could pay 2-4x, if oil falls below $100. I was too early on the July puts, but added to August $31 puts for .85 today, so my cost is now .93. If oil falls in the next few days, I will sell Julys against this position to hopefully get a nice cheap rider into what has been a tough month for oil the last five years, August. We got an almost uncanny identical spike in crude last year around this time, only to see it fall swiftly afterward:

Oil is great at quickly derailing itself by causing economic damage at the pump and political pressure on several parties to address high prices, so it always seems to come back to reality eventually. With global economic growth so anemic and the dollar in an uptrend, it is reasonable to expect a significant retracement of this spike at some point in the next two months. It also has a tendency to take a beating when the market sells off. So, it has multiple headwinds. Furthermore, the commitment of traders is ridiculously long:

Managed money is 10-1 long, and retail is 1.5-1 long, so any unwind could be a herding exercise.

I am also eyeing a weekly GLD spread sale, potentially on both the call and put side, an iron condor. Additionally, I am preparing for earnings season, where using calendars to arb implied volatility is a terrific way to get asymmetric risk/reward set-ups.

Follow @VolatilityWiz on twitter and stocktwits for real-time trading ideas. A subscription service is in the offing; if you are interested in receiving information on this in the near future, shoot me an email using the contact link above.

Bears got downright giddy today, as for an hour the most famous 50 day moving average in years seemed to finally be predictive of a price direction lower. But in the end, it was a non-event. S&P ended basically flat, the indicative value of the VXX was down 6 cents, and the VIX up 7 bps.

Everyone is still predicting that the 50 day is going to reject the S&P to some sort of target, fib level, or new channel, but it is not yet obliging. Resilient is an appropriate description for this market. While the S&P has been channeling the 1600-1620 range for the past week, don’t look now but a bullish MACD cross is about to occur:

S&P volatility has remained quietly under 17 for 4 days now, but the VIX futures are still expecting higher vol. In fact the open interest in the SPY options is 2-1 puts to calls:

Why are the futures trading this high above spot VIX with 8.5 trading days to expiration? I would have thought that they would have fallen closer to spot by now, with all the time decay in the offing, although there’s that job number out there on Friday. Could there be another volatility exhale after that number satisfies the market by being good, but not too good?

Who knows, but one thing is certain. Until the market sells off and the VIX rises, the VXX will have a tough road to hoe. I am still long a few $18 July puts, almost just to see how this decay/jobs number/50 day resolves itself. If for some reason, Friday goes well and the market breaks the 50 on it’s fourth attempt, these puts could double. If it doesn’t, then they will still have some value and I will look to exit near my cost. It is an asymmetric risk/reward at .14. Keep in mind that these puts have 3 days more life than the VIX futures.

But that is a minor position after we closed all our $19 puts for a 100% return. Other trades tweeted out this week include:

Short GLD weekly call spread, 122.5-124.5. Sold for .40, now .27

Short SPY weekly call spread, 163.5-165. Sold for .44, now .10

Sold VXX weekly call spread, 22-24. Sold for .52, now .05.

Sold VXX July 12th call spread, 20.5-22.5 for .40, now .44

Long UCO July puts for 1.05, now 1.15. Oil could fall dramatically with equity selling or Egypt resolution. It is at the high of the year on bearish fundamentals.

It has been a great week, all trades are working. This is a great environment to sell volatility. I do not anticipate any trading tomorrow if the open is not a significant gap.

Follow trades @VolatilityWiz on twitter and have an awesome holiday. We may post Friday should there be some job-related drama.