Fair Volatility Estimate Indicator - Revisited

- Fair Volatility Estimate (FVE) indicator is my own creation, and I believe with it, I could contribute much to the study of markets, of volatility, and of technical analysis. But I am yet unsure of its potential because FVE was developed just this summer. I have been observing FVE Indicator's signals and commenting about the market for the past few months. So far, my observations based on FVE has been very accurate. Of all the technical indicators I use to gauge market energy and it's ever changing flow, FVE is the most valuable and unique.

-I have searched the internet to see if there were other indicators like FVE. VIX is the most similar, but VIX is calculated from options prices on the S&P500 index. FVE is very similar to VIX in that it mirrors VIX (0.988 correlation, variance on FVE 5.29, while variance on VIX is 5.72 for data Jan-Sep 2010), but FVE is calculated from the price of the underlying (SPY in this instance), and not the price of its derivative.

- Why is this relevant? First of all, I would like to think that the FVE could be used as a simple, alternative way to measure appropriate implied volatility (IV) level of options, specifically, at-the-money IV of SPY options. Implied volatility can be described as the expectation of future realized volatility of the underlying by the options market. Well, if everything is already reflected in the Price of the underlying (as technical analysis assumes), why couldn't we estimate the future volatility of the underlying from the underlying market itself? I believe technical analysis adds great value, but technical analysts don't pay enough attention to the importance of volatility. On the other hand, mentioning technical analysis to vol traders would make you instantly lose credibility. Why such divide? I believe that there is value in technical analysis, in volatility analysis, and in technical analysis of volatility.

- FVE offers three general trading rules:

1) for directional or delta traders, when FVE is above/below its moving average, look to go short/long delta, especially when FVE's value has reached around its highest/lowest levels.

2) for gamma (options) traders, when FVE is rising/falling and above/below its moving average, look to go long/short gamma, and even vega especially when FVE's value has reached around its highest/lowest levels.

3) for options market makers, when implied volatility of SPY at-the-money options are significantly above/below (greater than 2-3 points) be better seller/buyer of options.

Examples of trading strategy 3 is on 11/1 ahead of elections and Fed meeting, implied volatility on SPY at-the-money options reached 21, but FVE indicator's value was 17.1. This was a good time to sell options and indeed, IV levels plunged the next few days to below 16. Also, on 11/24, implied volatility of SPY atm options were 16.3, while FVE indicator's value was 19.2. This was a good time to buy options, and on Friday 11/26, implied volatility of SPY atm options soared to 19.3.

SPY 117.5 - 123, Trading Range Scenario Ongoing

-Despite some volatile up & down movement, SPY is moving as was expected back on 11/17/10, within a trading range, and given the environment of rising uncertainty abroad with improving economic fundamentals here in the U.S., I would think that the 117.5 - 123 trading range for the remainder of the year is the likely scenario.

-And perhaps, this scenario is what options investors are betting as the likely scenario as well, since mean implied volatility index is 16.43% versus 19.8 figure shown by Fair Volatility Estimate Indicator. Even when taking into account Thanksgiving holiday and the weekend, implied volatility seems low when compared to the way SPY is moving.

SPY Expected To Move In Trading Range

- SPY long position stop/loss triggered on Monday at open. Most of my indicators are in short-term bearish mode, but I see two scenarios of SPY moving for the remainder of the year, either moving within 117.3 - 122.5 trading range, or 115 - 122.0 trading range. Either way, since I'm expecting SPY to be range bound, the best trading strategy would be to use overbought/oversold indicators (like Stochastic Oscillator) that work best in trading ranges.

- A more sophisticated strategy would be to sell slightly out-of-the-money puts when Stochastic Oscillator turns up from oversold condition and buy at-the-money puts when it turns down from overbought condition.

-FVE indicator's value is 20.3 while SPY mean implied volatility according to IVolatility.com is 19. Because FVE is above it's moving average and higher than implied volatility, I would still be hesistant to short volatility.

AAPL Stock Looks Vulnerable To Downside

- It isn't often I post a technical snapshot of stocks other than SPY, but I wanted to share with you my technical analysis of AAPL, because the stock looks vulnerable to the downside.

- While AAPL prices hit consecutive new highs (albeit barely) in the past few weeks, most my indicators failed to do so. Could this be a classic case of bearish divergence?

-As for SPY, while Friday's close of 120.20 keeps it within the bullish channel, my indicators are showing higher probability that SPY could break out of this bull-run into a new pattern. What that pattern would be is yet to be determined, but I would think that SPY would move within 117.5 - 123 trading range for the remainder of the year.

- December and January expiration options have traditionally been good months to sell premium due to the upcoming holidays. My FVE indicator is rising, however, so I would hold off selling options until a more opportune time.

Reducing SPY Long Positions.

- I am exiting out of my long call spread position at open for following reasons. 1) US Dollar is showing the most strength it has in the past 2 and half months, obviously due to rising concerns once again from Europe's weaker economies. 2) CSCO stock's plunge after earnings is not a good sign, and besides technical snapshot of AAPL, the leader of tech stocks looks weak. 3) SPY has had a tremendous run, and even though it is still moving within the steep rising channel, my feeling is that SPY will undergo a period of consolidation.

- I would like to take all the long positions off, but will maintain discipline and keep the 45 SPY shares long, but with a profit/stop of 119.5

- FVE indicator is starting to rise again, 16.2 vs mean SPY implied volatility of 15.9 according to IVolatility.com as of yesterday's close. Obviously with SPY premarket being down, implied volatility would likely spike up, but I would look for opportunitites to buy options.

Wow! That's All I Can Say.

- I'm glad to have followed my indicators and reentered long positions at 118.4 and 119.48, after having exited at 116.6. This market is exceptionally strong! That having been said, SPY is in very overbought territory, so I'll be vigilant about seeing any bearishness in the indicators.

-Implied volatility has dropped to 16.4, which is closer to FVE value of 15.3. Both values are at very low levels, so I'd be vigilant as well about developments in the market that could spike volatility back up. I'd not be adding to existing short gamma/vega positions.

SPY Continues to Move Within Rising Channel

-SPY continues to move within rising channel. Added to Long position by buying 45 shares of SPY at closing price of 119.48 on Tuesday. All technical indicators still pointing to bullish market.

-FVE indicator crossed back below moving average on 11/1, once again reaffirming the likelihood that implied volatility was going lower after rising ahead of the uncertain election results and FED announcement.

-Stop/Loss is now intraday price of 117.8 or closing price below the trendline support, which is currently 118.35 level.