We will be using our Volatility-Based Technical Analysis (VBTA) to gain additional perspective to what can be offered versus traditional technical analysis. During the last two months, I continue to get asked the same question, “Don’t you expect a rally in volatility?” The answer has been, “No.”  And it has paid off extremely well as we have been mostly long during this time period. And this was during the Greek tragedy part II and everyone and their mother trying to call a market top. Let’s take a look at what has been driving our opinion of compressing vols. Below, is the daily chart that I published on 2.4.2012 which comes from Friday’s close. I have shaded current/important support/resistance levels that we calculate through volatility math.

Here are the objective take aways:
•Support has continued to cascade lower
•Bounces in volatility have been countertrend off of said support and they have been contained well by resistance (can especially see this intraday – not shown)
•Trend & Trend Strength continues to be negative (hashed red lines circled below)
•VXN is not extremely oversold, volatility-wise (we trend compensate the indicator – circled in the bottom pane)•Immediate support and resistance (N Bands) are falling, giving VXN more room on the downside and less on the upside
•The biggest thing is the range created by volatility based support/resistance 14.81-19.10 

In summary, the evidence points to vols continuing to compress. There will most likely be periodic hiccups, that are tradable though, if you know how to find valid support. In fact, if you pull up the chart, you’ll see that this upper level is holding nicely. I have also included some levels above this range. I would look to take action at these levels if some unexpected news were to come into the market place and drive the vols higher. Finally, I will be extremely cautious at the lower end of this range as it is support from multiple time frames. You can find out more about (VBTA) and The A Game Trading Letter which applies it here: http://metaswing.com/site/a-game-trade-letter/ 

Monday, U.S equities finished flat for the day. Brent traded and settled at a $2 premium to WTI. The Euro traded in a narrow trading range for most of the day at the 1.3 level. Is all the bad news priced in the Euro or will the market witness more “headline risk” in the near future? The USD traded higher all day and finished near its Fri highs. While the world is awaiting Greek PSI negotiations to conclude.. The S&P had its lowest “non-holiday” volume trading day in over 10 years. Overseas market moving events for Tues trading include Germany IP #/Taiwan exports and Merkel will give a speech on Europe’s future.  In U.S markets, Lazard, Yum brands, and Anadarko are reporting Tues. Bernanke will testify before congress regarding the budget.

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Range Resources closed above its 200-DMA for the first time in three weeks.  It closed up 2.75% to $60.82. The 50-dma is $61.48 and a break of that would serve as the next buy point. I am not sure how many people are aware but EOG Resources stands for, “Enron Oil and Gas”, which is my mind is pretty hilarious. EOG has showed incredible strength since it began rallying off of the October 4 lows. The stock cleared major resistance in the $108 area and looks like it will be a straight shot to $112. EOG closed up .90% to $110.04. So far the SPX move that we have seen since the start of the year has been the best start in 25 years. Crude oil was down today due to investor concern that Greece will not be able to avoid a default. I am surprised that markets are even responding to news about Greece at this point. The SPY is still showing resilience and maintaining a strong uptrend.

Reason I like this Trade: I like this trade when I saw a customer buy 1500 CEDC Feb 5 Calls for $.65 when the stock was trading $5.52.  CEDC disturbutes alcohol products in European countries.  I guess I should have bought these Calls as well, but I decided to sell the Puts for $.20 instead.  The stock has rallied $.40 to $5.92 and the Calls have outperformed the price of the Puts.  I will leave these Puts on until expiration, as I do not get “LONG” stock until CEDC sells off 20% in the next 9 trading days.  If you have any questions please email me at  andrew@keeneonthemarket.com.

UPDATE 2.7.2012 With the stock selling off $.20, these Puts are worth $.175.  The longer until expiration the less these Puts will be worth.  With the stock looking strong above $5, I will leave these Puts on until expiration, so I do not chop my P&L with commissions.

UPDATE 2.8.2012 With the stock rallying to $6 and I realize that I should have bought the Calls instead of selling the Puts.  These Puts are now worth $.10, but will leave them on until expiration, so I do not chop my P&L up with commissions.  Moving to the next trade

UPDATE 2.14.2012 With the stock raging abovew $6.25, these Puts are basically worthless, but no trade is a complete winner until it is closed, so waiting until Friday and will not be taking any of this position off until then.

UPDATE 2.16.2012 With these options expiring tomorrow, these will be worth zero and I turned a nice profit and moving on to the next trade.

In unusual activity we see a customer once again buy the DLPH March 30-35 Call Spread for $1.60 as this stock continues to see bullish order flow.  We also see a customer seller of about 5500 CIGX May 2.5 Calls from $.70 which is the bearish acitivity I have seen today.  In other bullish order flow, we saw a customer seller of SNTA August 5 Puts for $1.00 and a customer buyer of LPS Feb 19 Calls for $.90.  I always try not to overtrade, but when I get a good trade like CIGX I jump on board on a short position.  The rest of the afternoon might be slow, but I am always watching the unusual options activity for possible trades.  

Of course the tough part is knowing when to switch trends. Wall Streeters use a million different indicators and ratios to try to figure this out, but as yet nobody has it down pat. Rather, all we can do is identify a major trend, and stay with it until is appears to be broken, and then move on. So what are the hot trends right now? What is going on out there that can make us some money? Market observers have commented on many trends that have been occurring for months. 

For example, one key trend has been the high correlation of asset classes over the past months. Historically, some assets classes—such as gold, various bonds, and certain commodities have been good hedges against stocks. They go up when stocks go down and vice-versa.  However, recently almost all assets classes have moved together—they go up together; they go down together. Is this trend continuing as we speak? Answer: uncertain. So far during 2012, certain market sectors (e.g. technology and banks), as well as bonds, haveclearly outperformed other investments (e.g. gold).  But whether the overall high correlation trend is broken remains uncertain. Another commonly discussed trend is the low volume in the markets and the vast amount of funds sitting on the sidelines. Certainly, these funds becoming more active could help the market. In the last few days, volume has moved up somewhat, but it is again uncertain how long the low-volume trend will last.

However, there is one key trend that has lasted for years, and for me is the most important trend to watch and to react to with your money. That trend has to do with action in the dollar. This dollar trend has been amazingly consistent over the past few months. Under this trend, there has been a very strong correlation between high markets and a weak dollar.  When the dollar is weak, markets go up.  When the dollar strengthens, markets go down.  This relationship has generally been holding true to form – day in and day out – month in and month out. This is the trend I am watching closest.Absent a Black Swan event, I believe that the markets will continue to do well as long as there is a weak dollar. While a strong dollar may be good for the US over the long term, a weak dollar helps stocks, gold, bonds, and commodities in the short term.  If the dollar strengthens, the markets may well act very negatively in response.Past trends are not necessarily indications of the future. However, investors disregard current trends at their peril. In my opinion, following a current trend is simply wise investing—until that trend changes course.  And right now the key trend out there is the weak dollar.  If this trend changes, my current bullish attitude will likely change very, very quickly. Please follow me on Twitter @USKOTM

Some key European events that traders will be watching this week are German factory orders(December) on Mon and will be listening to the Eurogroup finance minister meetings.  Tuesday, Bernanke will testify before the budget committee and Merkel will speak regarding Europe’s fiscal future.
 In early morning trading, after 5 weeks of positive trading/strong macro data and the Dow making fresh 3 year highs the DJIA is down by 45 points and the S&P is down around 5 points. The VIX traded under  17 on Fri but closed near its highs after investors wanted cheap protection. Perhaps investors were seeking some cheap protection against a “Lehman-like” event.
If the 10 yr yield can trade comfortably above 2% and the Vix can trade under 20 I think the tape is set to trade much higher. Crude oil is trading around the 97$ level with a lot of risk premium still built in. Look for crude oil to go much lower unless some crazy geo-political news comes out of the middle east.