Stocks, ETFs, Options, Commodities & Currencies

Oil prices have been in the spotlight as the Syrian chemical weapons crisis became front and center in the media. As the political process has unfolded, price volatility in oil futures in both directions has been extreme. Oil prices have traded in a wide range the past two weeks between $104 – $112 dollars per barrel.

As a professional option trader, I wanted to look at what the implied volatility within options on oil futures was saying about future oil prices. The oil futures option chain would give me some possible clues about near and intermediate term price direction.

As an options trader, I am constantly focused on implied volatility. I regularly look for stocks or futures that are showing implied volatility levels which are higher than their historical average. The very first thing I look at is the implied volatility skew across multiple option chains with different expiration dates. As such, when I looked at the oil futures option chains I noticed that the longer dated expirations had a slightly higher than normal implied volatility.

It is normal for the longer dated expirations to have higher volatility levels, but what was striking to me was the implied volatility in December was not much higher in the December oil futures options than what it is in the front month expiration. I found this odd so I looked at the spot oil futures prices going out in time. The following chart comes directly from www.cmegroup.com.
*

As can be seen, as you move out further in time the oil futures prices decline. This is a condition in the oil futures market known as backwardation.

According to Goldman Sachs in an article posted HERE:
“This rise in backwardation in oil, in our view, is not driven by the events in Syria, but rather by increasingly tighter fundamentals that are a result of the production shortfalls in Libya and Iraq against improving Chinese demand.”

Essentially Goldman Sachs’ analysts go on to say that they believe oil prices will see modest declines over the next 12 months, but the backwardation will likely lead to returns being mostly flat over the next year.

The fundamental backdrop according to Goldman Sachs appears to be bullish in the short-term based on supply data. Unfortunately fundamentals usually explain why an underlying asset moved the way it did after the fact. Making money in the short term as a trader is difficult when basing entry and exit decisions solely on fundamentals.

With the fundamental backdrop explained, I thought it would make sense to look at key technical levels in the oil futures price chart. The chart below illustrates key price levels based on recent price action in oil.



Obviously the consolidation zone is setting up for a large move in oil prices. The more important question to answer is which direction will oil prices move? Will we see activity or supply data that pushes prices above the resistance zone? Under that scenario, the next logical price target for oil would be between $121 – $130 per barrel.

Should prices reverse course and break below support we should see strong buyers come in around the $90 – $95 per barrel price zone. At this point, the next stage in my analysis is going to be probability based support and resistance for oil futures.

This process has to do with calculations involving implied volatility to derive a probability based on price action today. Clearly those probabilities change constantly, but the probability data set is accurate in real time or at the time of entry.

Traditionally I will use standard deviations to help determine price ranges as well as setting up trades that are directional such as credit or debit spreads. Other times I will use standard deviations to place credit spreads like Iron condors which focus more on the passage of time and are generally more agnostic to price action.

One standard deviation is typically calculated as 68%. Based on the options on oil futures which expire in 36 days on October 18^th, a one standard deviation move would place oil prices around $103 per barrel to the downside. A one standard deviation move to the upside based on Wednesday’s closing prices would put oil prices around $110 per barrel.
Interestingly enough, the price range expectations for a one standard deviation move from current prices today (09/11) at the close fits precisely into the price range discussed above using technical analysis.

Varying data lining up like this does not always happen this precisely, however when key price levels line up in this manner it should not be ignored. The option data is basically indicating that there is a better than 68% probability that in 36 days the price of oil will be in the $103 – $110 per barrel price range.

The oil futures price chart shown below illustrates a two standard deviation move. The lines drawn on the chart below demonstrate the next key price levels should a 2 standard deviation move occur from the current price at the October option expiration.



It is important to understand that there is roughly a 10% probability that oil will even touch either key price level shown above before the October 18^th expiration. So what do all of these probability calculations tell us?
Right now the implied volatility in the options that expire on October 18, 2013 based on current oil futures spot prices has a low probability of seeing a surge higher or a major move lower. The option data essentially concurs with Goldman Sachs fundamental view that oil prices are likely to stay in a trading range and probabilities do not favor a big unexpected move.

I would point out however, that the probabilities for a big move are not 0%. There is a 1 in 10 chance that we see a big surge or breakdown in price. As far as I am concerned, this is the option markets calculated odds on any major escalation taking place in Syria or the Middle East prior to October 18, 2013.

I think in the short-term we could see oil futures prices move up toward $115 / barrel. However, the probabilities simply do not favor a prolonged move above that level. Furthermore, it seems likely that when the Syrian debacle concludes that prices will be more likely to be in the $103 – $110 price range in roughly one month.
Instead of reading articles written by pundits who are making price projections based on an educated guess, why not let the options market be a guide for where the marketplace is pricing in the next move. The analysts that are calling for a monster move in oil in the near term have roughly a 10% probability of being right. I will let readers decide whether a pundit or the option pricing in oil futures is likely to be more accurate.

See more here.

While the indexes continue to sputter on news out of Washington, we continue to focus on the charts and trade with the trend and what we see.

As usual, the media is playing with human emotions – Fear. As talked about before, fear in my opinion the most powerful emotion and force in the financial market. So when true fear hits the country it will be clear to see, but right now, investors are in no rush to sell their positions in stocks just yet.

If our leaders fail to come to some agreement in the next couple weeks the question many want to
know is

How Will We Trade This Event/News?

The answer: we ignore it. Though we could reduce position sizes to be safe when the time comes on Oct 17th.

During most bull markets, there is typically a “wall of worry” to traders and investors climb. The details are different every time, but there are usually one or two major “risk factors” that investors worry about when the broad market is trending higher.

Traders and investors who focus on doom and gloom headlines are more than likely to be shaken out of their long positions…especially those who lack conviction in their trading system.
Conversely, I focus on individual price and volume action of leading sectors and ETFs.

Holding long positions through market corrections is never easy, but it is NOT our job to decide when a trend is over.

If we approach trading with a clear and objective mindset, the stock market will always tell us what to do, based on the price, cycles and volume action. If our ETF positions sell off to trigger our protective stops, we will simply be forced into 100% cash position.

The beauty of such a rule-based trading is that it removes some human emotion and guesswork from trading.

This increases our long-term trading success, and the added benefit of being calmer and stress-free, regardless of what is happening in the stock market.



Trading Plans…

If you are new to swing trading, or have had little success in the past with trading, it is a great idea to get in the habit of planning your trades (trading rules) and trading your plan.
You must continually try to identify all potential outcomes before entering a trade.

If you do, then you should not be surprised when price moves because you realize that anything is possible, and you have already accounted for it and used proper position management to protect capital and lock in partial gains.

Trading with rules allows you to prepare and worry before the trade takes place, so that you can focus on executing the plan when the time comes.

Above all, focus on the price, momentum and volume action, rather than the amount of profit or loss a trade is showing in your account.

If you focus on proven trading rules and execution, consistent trading profits will eventually and inevitably follow.

See more here.

By now the major media outlets have made sure to inform the public that the U.S. government is shut down, or partially shut down depending on your political perspective. Most financial pundits are looking to the recent past for clues about what to expect in the future.

While the situation appears to be similar to what we witnessed in 2011 with the debt ceiling debacle, the outcomes may be significantly different. I am a contrarian trader by nature, and as such I am constantly expecting for markets to react in the opposite way from what the majority of investors expect.

A significant number of financial pundits and writers all have a similar perspective about what is likely to occur. It seems most of the financial punditry believe that until there is a resolution in the ongoing government debacle, market participants should expect volatility to persist. Some of the talking heads are even calling for a sharp selloff if no decision on the debt ceiling is made by early next week.

The debt ceiling decision needs to be made by midnight on October 17th otherwise the first ever default on U.S. government debt could occur. Thus far, the volatility index (VIX) has moved higher as investors and money managers use the leverage in VIX options to hedge their long exposure.

As can be seen below, we are seeing the VIX trade at the second highest levels so far in 2013.



The volatility index (VIX) is clearly sending a warning signal about risk in the S&P 500 Index based on price action. However, that warning signal relies on current uncertainty in the marketplace. Most sell side analysts and economists believe that once a deal is done, risk assets will rally. What happens if they are wrong?

Trying to play a fool’s game by calling future price action correctly without supporting facts in hopes of being right is not honest analysis or commentary. Instead, why wouldn’t investors put the situation in context using information available from calculations derived from option chains? I want to be clear in saying I have no earthly idea what is going to happen once a deal is reached or when said deal will be reached. I have no idea!
Readers should be completely leery of anyone trying to tell you what is going to happen with supposed certainty. Whether they want to admit it or not, no one in the financial punditry knows for sure what is going to happen.

I believe that the options marketplace is much more competent about future price action than some financial pundit or sell side analyst that is trying to push their book of assets. As such, the S&P 500 Cash Index (SPX) option chain is shown below:




As can be seen above, the probability that the SPX 1,620 October 10/25 Put expires worthless is roughly 68%, or 1 standard deviation from Wednesday’s closing price. The probability of the SPX 1,685 October 10/25 Call expiring worthless is also roughly 68%, or 1 standard deviation to the upside from Wednesday’s closing price.
As of the closing bell on Wednesday, October 9th the SPX options chain is telling us that there is a 68% probability that price will stay between 1,620 and 1,685 by the close of business on Friday, October 25th.

Where the probability analysis gets interesting is when we look at a 2 standard deviation move which gives us a near 90% probability of being accurate with our expected price range. The 2 standard deviation move from the October 9th close on the put side is 1,525. The 2 standard deviation move from the October 9th closing bell on the call side is 1,720.

Thus, as of the closing bell on Wednesday, October 7th the SPX options chain is telling traders that there is a 90% probability that the S&P 500 Cash Index (SPX) will close on October 25th between 1,525 and 1,720.
This analysis gives us some expected price ranges for the S&P 500 in the near future. However, there is something I want to point out to readers about what the SPX option chain is telling careful observers. As of the close of business on October 9th, the S&P 500 Cash Index closed the day at 1,656. At this point we need to revisit the previous price ranges.

The one standard deviation (68%) price range is shown below:



As can be seen, the 1 standard deviation price range is centered fairly well with the closing price on 10/09. However, it should be noted that the SPX options chain is implying slightly more risk to the downside. Consequently, something rather significant occurs when we look at the 2 standard deviation (90% probability) expected range for the SPX options chain.

The two standard deviation price range is shown below:



The upside expectation that has a 90% probability of being accurate implies a 3.86% increase potential by October 25^th. However, the 90% probability of being accurate to the downside implies a -7.91% move. Clearly the option market is telling us that the marketplace believes there is much more possible risk to the downside.
The question I would pose to readers and financial pundits alike is the outcome no one is talking about. What is the least likely outcome for the markets to traverse? In my humble opinion, the least likely expectation would be that we get a resolution regarding the government shutdown and the debt ceiling. Then as expected risk assets rally sharply higher, only to reverse and selloff sharply a short time later.

That would be the least likely scenario that market participants would expect and a large downside move is being priced into the S&P 500 Index option chain. I want to reiterate that I have no idea what is going to happen, but what I do know is the S&P 500 Index options are telling us that it is possible for a large selloff to potentially occur.

The most important question of all is what source of information is more credible? Is information coming directly from the marketplace in an extremely liquid underlying asset like SPX options credible? Or is a financial pundit trying to push their book of assets or their firm’s book a more likely source of honest information? I will let readers decide.

See more here.

Last week on October 8^th the financial market experienced a broad based sell off. Every sector was down with utilities being the only exception.
The individual leadership stocks, which are typically small to mid-cap companies (IWM – Russell 2K) that have a strong history and outlook of earnings growth, were hit hard as well.
Whenever the broad market experiences a price correction, one of the most important factors I analyze is*how well leading stocks hold up and show relative strength*to the broad market.
So, where does this leave us going forward?
When stocks that have been leading the market higher and only pausing during market corrections in the S&P500, Dow, and NASDAQ, it’s a positive sign. This tells us investors and big money continues to flow into the risk on assets (stocks).
Conversely, when these leading stocks/sectors begin succumbing to the selling pressure of the broad market, it quickly grabs my attention and tells us it’s*time to be aware that a major top may be forming.
It looks as though the broad market rally is just barely hanging on. If the leading stocks and sectors begin breaking below their 50-day moving averages, my proprietary*SP500 Market Timing & Trading System will shift to sell mode and things could get ugly for those who do not know how to trade a bear market.

Weekly Relative Strength Showing Negative Divergence

This chart has two important things I would like to point out. First is the fact that the RSI has being overbought twice in the past three years with the most recent one taking place a few months ago. The last time this took place the SP500 had a very strong correction.
The second insight the RSI is providing us with is the diverging price and relative strength as shown with the purple lines on the chart below. This is telling us that the power/momentum behind the market is slowing.



Daily Bullish Percent Index – Shows Negative Divergence

I always prefer to watch and analyze the NYSE as it’s the big board where all the HUGE money is flowing from traders and investors. The chart below clearly shows that less stocks are moving higher as seen with the purple bullish percent index line. With less stocks making new highs, yet the stock market continues to climb this is a warning sign that this bull market is slowly running out of steam.



Technology & Financial Sector Are Rising But For How Long?

Two very powerful sectors are holding up well but once they start to breakdown from these chart patterns things could get ugly real quick. Our 3x ETF trading newsletter becomes very active in bear markets as the upside potential is much larger.

The XLK technology sector looks to be forming a bearish rising wedge. If/once it starts to slide it will have a strong impact on the broad market.



Financial Sector XLF

The recent price action of scattered trading ranges looks to be similar to the top we saw in 2011. If this is the case then we have bearish head & shoulders pattern with a rising neckline forming. Once price breaks through the neck line we should expect sharp drop in price.
This sector is heavily weighted in the SP500 so if it start to drop, expect the SP500 to fall with it.


Major Market Top Lurking…

The chart below pointing out the next bear market likely to take place is a scary looking chart to most individuals. But if you know what you are doing, they can provide more profits in a shorter period of time than a four year bull market.

If this market is starting to stall out and is in the process of forming a top. Keep in mind that market tops are a process. They take typically 3-6 months to form before a true breakdown occurs and the bear market starts. And until then, price will be choppy and difficult to trade.



Cautious Trading Conclusion:

In short, this report shows you some major divergences in the financial market. Remember, you do not really trade off divergences, as they are not good at timing. They are simply a warning sign telling us that something large is brewing and that risk is higher than normal.
There are few ETFs I like on various sectors and commodities that show some oversized upside potential in the coming weeks/months. Depending on what takes place in Washington this week will move the market and likely trigger some sharp moves. Until then, sitting tight is the safe play.

See morehere.

The precious metal market has been stuck in a strong down trend since 2012. But the recent chart, volume and technical analysis is starting to show some signs that a bottom may have already taken place.

This report focused on the weekly and monthly charts which allow us to see the bigger picture of where the precious metals sector stands in terms of its trend.

Gold Spot Price – Weekly Chart

This chart clearly shows the trends which gold has gone through in the last three years. With simple technical analysis trend lines, clearly price is nearing a significant apex which will result in a strong breakout in either direction.

Remember, this is the weekly chart, so we could still have another month or three of sideways
chatter to work through. But a breakout in either direction will trigger a large move.



Silver Spot Price – Weekly Chart

Silver is also stuck in a similar pattern.* Currently the odds still favors lower prices and for the upper resistance trend line to reject price and send it lower. But if we keep out eye on the leading indicators like gold miners, we may be able to catch a breakout or traded the rejection of resistance in the next month or so.




Gold Mining Stock ETF – Monthly Chart

Gold miners have a very sloppy looking chart. Price is extremely volatile and the recent price action in 2013 could go either way VERY quickly. I have a gut feeling GDX in the coming months could have a washout bottom and tag the $20 price level. While I hope I am wrong for many investors sake, if it does happen, it will be a very strong investment level to accumulate a position.



Precious Metals Bigger Picture Outlook:

In short, I remain neutral – bearish for this sector.* In the next 1-3 months we are likely to see some strong price action which will be great. We need a breakout or bottoming pattern to form before we get involved at this level.
I know everyone is dying to get involved in precious metals again for another huge rally… but sometimes it’s just best to wait for the big picture chart to catch up with your bias before taking a position of size.

See more here.

Traders and investors all around the world is having trouble climbing over the wall of worry/fear with the US stock market, and rightly so. There is a lot of things taking place and unfolding that carry a high level of uncertainty. Let’s face it, who wants to invest money into the market when it’s hard to come by (high unemployment, banks are still extremely tight with their money, companies are nowhere near wanting to hiring new staff).

The hard pill to swallow is the fact that the stock market loves to rise when uncertainty is high. It’s almost doing it just to drive investor’s nuts who sold out near market bottom or recent correction. You must overcome the urge to short the market when the economy looks so bearish in the years ahead, and continue to trade with the trend.

Short Term Investing – Weekly Volatility Index Chart

Below you can see the fear index. The chart is self-explanatory showing where it should move next. But if you are not familiar with the VIX then here is definition by investopedia:
“The first VIX, introduced by the CBOE in 1993, was a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors’ expectations on future market volatility. VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.”



Weekly Investing Chart of the SP500 Index

After reviewing the VIX chart above which points to stocks nearing a level of selling pressure, then review the chart below we come to a conclusion that a minor pullback of 2-5% is likely to take place in the next week ortwo.

The divergence in the Relative Strength Index is a bearish sign for the broad market. While I feel a pullback is do and needed for the market to regroup, it is important to review the seasonality chart and know that we are entering one the strongest times of the year for stocks.



SP500 Seasonality Chart

Again, using the data from the previous two charts along with this graph clearly shows that a pullback in the stocks is likely going to be bought back up by the brave investors willing to override their fear and go with the trend. For more interesting charts check out my stock chartlists:*https://stockcharts.com/public/1992897

*

The Wall Of Worry Conclusion:

In short, expect the stock market to correct in the next week or two. But once we get a correction of two percent or more, be prepared for buyers to step back in and buy things up into year end.
This WALL OF WORRY is about to GET HIGHER!
Get These Reports Delivered To
You Inbox Each Week Free:
www.GoldAndOilGuy.com

Chris Vermeulen

See more here.

My Stock market trend analysis is likely different from what you think is about to unfold. Keep an open mind as this is just showing you both sides of the coin from a technical stand point. Remember, the market likes to trend in the direction which causes the most investor pain.
Since the stock market bottom in 2009 equities has been rising which is great, but this train could be setting up to do the unthinkable. What do I mean? Well, let’s take a look at the two possible outcomes.

The Bear Market Trend & Investor Negative Credit

The S&P500 has been forming a large broadening formation over the last 13 years. The recent run to new highs and record amounts of money being borrowed to buy stocks on margin has me skeptical about prices continuing higher.

Take a look at the chart below which I found on the ZeroHedge website last week. This chart shows the SP500 index relative to positive and negative investor credit balances. As you can see we are starting to reach some extreme leverage again on the stock market. I do feel we are close to a strong correction or possible bear market, but we must remember that a correction may be all we get. It does not take much for this type of borrowed money to be washed clean and removed. A simple 2-6 week correction will do this and then stocks will be free to continue higher.



Monthly Bearish Trend Outlook

Below you can see the simple logical move that should occur next for stocks based on the average bull market lasts four years (it has been four years) and the fact the negative credit is so high again.
Also, poor earnings continue to be released for many individual names across all sectors of the market. While corporate profits may be holding up or growing in some of the big name stocks, revenues are not. This means the big guys are simply laying off workers and cutting costs still.

Overall the stock market is entering its strongest period of the year. So things could get choppy here with strong up and down days until Jan. After that stocks could start to top out and eventually confirm a down trend. Keep in mind, major market tops are a process. They take 6-12 months to form so do not think this is a simple short trade. The market will be choppy until a confirmed down trend is in place.



Monthly BULLISH Trend Outlook

This scenario is the least likely one floating around market participant’s minds. It just does not seem possible with the global issues trying to be resolved. With the Federal Reserve continuing to print tens of billions of dollars each month inflating the stocks market this bullish scenario has some legs to stand on and makes for the perfect “Wall of Worry” for stocks to climb.

The US dollar is likely to continue falling in the long run, but I do not think it will collapse. Instead, it will likely grind lower and trade almost in a sideways pattern for years to come.



Major Stock Market Trend Conclusion:

In summary, I remain bullish with the trend, but once price and the technical indicators confirm a down trend I will happily jump ships and take advantage of lower prices.

Remember, this is big picture stuff using Monthly and quarterly charts. So these plays will take some time to unfold and within these larger moves are many shorter term opportunities that we will be trading regardless of which direction the market is trending. As active traders and investors we will profit either way.

See morе here.

Trading around a core position using elliott wave analysis: DATA

Often you can spend a fair amount of time with “dead money” in a growth stock that you love, but again, your money is sitting dead for weeks or even months on end while you hold it.
What we often do at ATP is try to trade around a Core long position, in this case we look at DATA (Tableau Software).

We first picked up a Full position at around $55 per share in the late summer
We sold 1/2 at 59, bought it back at 55 for a net average of 51 on 1/2 the position.
Then we sold that 1/2 at 72-73 after 2nd quarter earnings for huge 32% gains
Then we just bought it back at 60-61 when that gap in the chart we watched for a few months finally filled last week.

We just sold that 1/2 for 69 this morning for a 14% gain

We still hold the original 1/2 from 55, but net net we have booked huge gains by trading around this core holding.

Below is the chart showing you our entry and exit points, and again in the meantime we continue to hold the original 1/2 from $55.
55-59- *9%
55-73- 32%
61-69- 14%

So 3 trades of 9, 32 and 14% on 1/2 , while still holding 1/2 currently up 25%.






See more here.

The SP 500 staged an improbable come back on Friday November 8th from the 1747 lows of Thursday.
As it turns out, an examination of the shorter term waves can call the low at 1747 an ABC wave 4 bottom, and now wave 5 up to complete Major wave 3 seems under-way. Our Elliott Wave analysis continues on track, but a few short term adjustments are in order.

We had Elliott Wave targets of 1768-1829 for weeks now in that wide range. At 1829 we have symmetry with a 562 point rally from 1267 Major 2 lows, and that 562 is virtually identical to *the 666-1221 wave structure off the bull market cycle lows in March 2009. *That rally was 555 points, so at 1822 in fact we would have a nice neat 555 point Major 3 rally of Primary 3 to equal the initial leg up of Primary 1

Below is our updated Elliott wave analysis for the market:

Key support is 1747, the 20 day moving average, below that and we have a truncated 5th wave of Major 3 and we head lower….
So lets look at 1778 resistance again (704 point rally off the 1074 Primary 2 lows and equal to 704 point Primary 1 rally)
And then 1822 as next up in line.
1778 resistance, 1747 key support, 1822 next top target.




See more here.

The incredible rally in equities in 2013 has begun to stir concern among many that the stock market is now in a bubble. We have entered the euphoric stage of this bull market and equity prices cannot and will not go lower according to some talking heads in the financial punditry.

While chatter is starting to heat up that equities are in a bubble, the real bubble seems to be ignored for the most part. The larger, more concerning bubble is in the Treasury marketplace where the Federal Reserve continues to print money to purchase treasury bonds to help keep interest rates artificially low.

Instead of debating the bubbles in Treasury’s versus equities, or trying to predict when the bubble in either asset class may pop, I want to focus on the near term for price action expectations in longer-dated Treasury bonds.
Below is a weekly chart of the Treasury ETF TLT which is supposed to reflect the price action and yield generation of a portfolio of 20+ year duration Treasury bonds issued by the U.S. federal government.



I have identified the key support areas which are supported by the price by volume indicator as well. No one in the financial media seems interested in discussing the nearly 13% drop year-to-date we have seen in longer-dated Treasury bonds shown above.

Furthermore, based on current price action we could see lower lows in the days and weeks ahead if price breaks below near-term support levels around $102.20 / share. I wanted to take this analysis one step further and look out into the future from an option trader’s perspective.

Based on the bill which was recently passed to reopen the government, there are two key dates which could impact Treasury bonds. The recently passed bill keeps the government open until January 15, 2014 at which point Congress will either compromise on a budget or accept additional sequester cuts. Furthermore, if no compromise is achieved and the sequester cuts are not favored, the federal government could shut down again.

The other key date is February 7^th which is the date where Congress will yet again hit the debt ceiling. It is likely that through special measures the Treasury can push that date beyond February. However, the debt ceiling discussion will yet again impact government bonds as the threat of another default will likely emerge if recent discussions are any blueprint for the future.

Since the key dates are known, it allows option traders to focus on a specific expiration month. Based on the debt ceiling date of February 7, I wanted to look at the March 2014 TLT option chain for clues about what the options marketplace is indicating about any future event(s) and the potential impact on Treasury prices.
The first thing I did was to check the implied volatility of the various monthly option expirations and I found a glaringly obvious warning signal. The table shown below demonstrates that implied volatility is higher on the March 2014 options than the December or January expirations.

Expiration Month	Implied Volatility – 11/14/13 Close
December Monthly	11.95%
January Monthly	12.17%
February Monthly	12.57%
March Monthly	13.20%

The March 2014 option series has 10.46% more implied volatility than the December 2013 monthly option series based on the November 14^th close. As can be seen above, the March monthly expiration has considerably higher implied volatility than the rest of the expiration series leading up to March.

Essentially this implied volatility skew is telling us that the option market believes that volatility will increase as we move into the March to April time frame. This corresponds with my expectations that Treasury’s may see serious price volatility late in the first quarter of 2014. The timeline fits nearly perfectly with the next debt ceiling discussion.
The next examination I look at is standard deviation based price levels to ascertain clues about the market’s expectations in the future. The TLT March 2014 monthly put option chain is shown below with the 1 standard deviation and 2 standard deviation price points highlighted.



The chart above illustrates the closing price levels on November 14, 2013. As can clearly be seen, the 99 strike is roughly 1 standard deviation (68% probability) lower from the closing price of $104.52 / share. A 2 standard deviation move (90% probability) corresponds with the 91 put strike.

What the March 2014 put option chain is telling probability based option traders is that implied volatility levels are indicating that there is a 68% probability that TLT closes above $99 / share. There is a 90% probability that price closes above $91 / share at the March monthly expiration. Now we will look at the call side of the March 2014 TLT option chain.



The closing price on November 13, 2013 was $104.52 / share. A 1 standard deviation (68% probability) corresponds to the 107 strike. A 2 standard deviation move (90% probability) corresponds with the 112 strike. Thus, there is a 68% probability that TLT closes below $107 / share at the March monthly option expiration. There is a 90% probability that price closes below $112 / share.

So what does this data tell option traders looking at probabilities? The answer is simple. The TLT March 2014 options’ implied volatility levels are telling us that presently the marketplace believes that TLT has a higher probability of being lower than today’s closing price of $104.52 / share on March 21, 2014.

There is a 68% probability that the price of TLT at the March expiration will be between $99 – $107 / share. There is a 90% probability that the price of TLT at the March expiration will be between $91 – $112 / share.

The one standard deviation upside strike is $107 / share which is just 2.37% above $104.52 / share. The downside strike is $99 / share which is 5.28% below today’s closing price. Based purely on those numbers, there is nearly a 2 : 1 probability that TLT’s closing price on March 21, 2014 will be below today’s closing price of $104.52 / share.

The same situation is true when we look at the 2 standard deviation predicted price range. The 90% probability upside target is $112 / share which would correspond with a 7.15% move to the upside. However, the 90% downside target is $91 / share which would correspond with a 12.93% move to the downside from today’s closing price.

I want to be clear that this does not mean TLT’s price will go down for sure. It is merely a road map as to what TLT’s option chain is indicating about future price action. It is without question that the implied volatility levels in March TLT options indicate that there is risk ahead regarding Treasury bonds.

Whether the risk revolves around the debt ceiling debate or a possible taper from the Federal Reserve is hard to know for sure, but at this point TLT is nearly 2 times more likely to move lower in the months ahead.

See more here.