Reading the VIX

A Double-Bottom Formation Spells Caution

By Bryan Bottarelli
Wednesday, June 10, 2009 10:38 AM EDT
Wed, 10 Jun 2009 14:38:00 GMT

PLAY: Buy the DXD July 45 Calls (DXD GS) at or under $2.75, good for the day. Place a protective stop limit at $1.30 and a pre-determined sniper sell at $5.00.

Dear Bottarelli Research Member,

Good morning. Although it’s still very early in today’s trading session, we’ve already seen some interesting developments. Now I admit, I typically don’t base too much on the first hour of trading – especially these days. But today, we cannot ignore the fact that the major market averages did something that we haven’t seen in quite a while. That is, they sold into a rally.

Looking at the Dow chart, it’s clear that the daily candlestick formations are getting smaller and smaller. This could signal exhaustion among the bulls. At the same time, it’s important to note that former leadership groups (such as financials) and standout stocks (such as Apple and Google) have both been weak in recent trading. This is another sign of exhaustion.

INDU

But in my view, the most telling signal comes from the CBOE Volatility Index (VIX). As you can see below, the so-called “fear gauge” has been dropping rather notably lately, which indicates that investors are not concerned about a coming market drop. But as I look at today’s chart, I’m seeing a solid double-bottom formation right around the 27.50 level. The last time the VIX tapped this level, it sparked a market sell-off that pushed the VIX back up to 35. In the context of the markets, that’s a sizable sell-off. And right now, we might be on the verge of another such move.

VIX

In preparation for this down-leg, I’d like to adhere to my alert from Friday, June 5th which was titled, “Dow 9,000, Then Sell?” As you can guess, this alert predicted that the Dow could touch 9,000 before selling off. But today’s high of 8,834, combined with the selling pressure and the VIX levels, indicates that the time to move is now. As a result, let’s add July calls on the Ultra Short Dow 30 ProShares (DXD – NYSE).

DXD

As you know, the DXD moves at a rate of twice the inverse of the Dow, so any forthcoming drop could push your call options higher. Let’s get positioned to profit off this move now!

PLAY: Buy the DXD July 45 Calls (DXD GS) at or under $2.75, good for the day. Place a protective stop limit at $1.30 and a pre-determined sniper sell at $5.00.

At the same time, maintain your BNI July 75 Puts (BNI SO), which are inching into the profit zone now. Also maintain your GDX July 40 Calls (GDX GN), which will prove to be a nice position if investors move back into gold. If DRYS can’t extend upon yesterday’s momentum, we’ll have no choice but to close out our DRYS June 7.50 Calls (OOC FU). And maintain your JRCC July 22.50 Calls (JQM GX), which moved back up to $3.00. As always, I’ll continue to update you throughout the trading session. Until then…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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