Having just broken out to new all time highs, the S&P 500 (SPX) is up 6.25% on the year, and up 20% from its 2016 lows at 1810, made on February 11th. It’ now 6.5% above its 200 day moving average:
As one might expect, spot VIX is very near its multi-year lows, and down 30% from its 200 day moving average, despite VIX Futures in November at 19:
These two charts scream Risk-ON. But it’s important to remember that there are a few (commonly thought of as) Risk-OFF signals flashing warning signs too.
First, Crude Oil at two month lows, below technical support at $45:
Gold is up 26% from its 52 week and multi year lows made in December:
And the U.S. Dollar is up 5% from its lows made in early May. It has now broken the downtrend that had been place since its highs made in early December. I view this as a flight to quality in a world where the British Pound is making 30 year lows, The Euro looks poised to make another shot at the 52 week lows, the Japanese Yen remains in a well defined downtrend and the Chinese Yuan trades near 6 year lows:
Oh, and one more. Interest rates, which are obviously intertwined with all of the above. The 10 year Treasury yield is at 1.55%, having just bounced off of all time lows at 1.33% earlier in the month. That still points to a flight to quality for U.S. Treasuries, hardly bullish:
Trying to pick a top in stocks, or setting up to own volatility in a period of low vol can be an expensive proposition, trust me. But trying to identify risk assets where it appears that the potential for volatility is under-appreciated can make sense from time to time.
Which leads me to the HYG, the iShares High Yield etf. Much like the SPX, at its current levels in terms of price and options suggests a certain level of complacency in HYG when you consider the potential for further US dollar strength causing further crude weakness. If that were to happen that could be the first challenge for stocks at all time highs, as it probably signals another global growth scare.
The HYG has consolidated over the last couple weeks trading in a very tight range, after breaking out of a three month range:
But the etf is now at what could be an important technical resistance level, the breakdown level from last September:
Short dated implied volatility is cheap as chips, with 30 day at the money iv at 7.25%, very near the 52 week low:
But in an etf like this, cheap can get cheaper, especially in Summer trading. It’s my view that if the U.S. dollar continues higher, possibly into or out of the FOMC’s rate meeting next week, then we could see lower lows in crude. Remember the commodity collapse started in 2014 as the Fed signaled to the Taper of QE, and accelerated in 2015 as the Fed signaled the end of ZIRP:
If we were to see Crude with a 3 handle in the coming weeks/months, I suspect we would see the HYG give up a lot of its recent gains. And with vol as cheap as it is in the etf, puts or put spreads could offer an attractive risk reward if we see anything resembling the January/February risk asset volatility later in the year.
So what’s the trade?
*HYG ($86.08) Buy Aug / Oct 84 Put Calendar for $1.20
- Sell to open 1 Aug 84 put at 25 cents
- Buy to open 1 Oct 84 put for $1.45
Break-Even on Aug Expiration:
Ideally HYG stays in its current range and pulls back slightly towards 84. If that were the case then the August puts would expire worthless and do their job at financing the October puts. We could then roll the short strike out and down. Sideways action is fine into August expiration. A breakout higher and we’d have to keep a bit of a leash on it because we wouldn’t want the October puts to get too far away from where the ETF is trading. This is a defined risk way to position for any bout of volatility in the next few months and we targeted HYG specifically as a way to express that that volatility, if it comes, could very likely come continued strengthening in the US Dollar. Speaking of the dollar, we’re also positioned for it to go higher with a UUP trade from July 15th.