Pulling The Cord

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Includes: CVOL, DRR, ERO, EUFX, EUO, FXE, IVOP, SVXY, TVIX, TVIZ, UDN, ULE, URR, USDU, UUP, UVXY, VIIX, VIIZ, VIXM, VIXY, VMAX, VMIN, VXX, VXZ, XIV, XVZ, XXV, ZIV
by: Ivan Martchev

Since it is August and I finally got to take a two-week vacation, I pulled the cord on the constant Internet stream and the fascinating world of financial markets for about a week. Situated in a mountain resort about 5,000 miles from New York, it only seemed appropriate to tune out for a week, but I went online this past Sunday and looked at the main indicators. The latest rise in the euro (to U.S. dollar) jumped out at me.

The dollar was down a lot last Friday. Since the biggest component of the U.S. Dollar Index is the euro, that means the euro was up a lot, closing near $1.20 per dollar. This was due to a one-two punch delivered from two consecutive speeches by Janet Yellen and Mario Draghi, which traders read as euro-bullish.

EuroUSD-ExchangeRate.jpg

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I think the euro is overshooting a bit now, due to the unwinding of the eurozone disintegration trade. The Netherlands and France both had pro-EU elections and everyone now assumes that Germany will see a Chancellor Merkel win in September. All the fears of a disintegrating eurozone that plagued the market in January are now past. Still, $1.20, which held as support for a decade, should now become resistance. By this, I mean that the "1.20 area," not the round number, should see sellers emerge that used to be buyers.

UnitedStatesDollarIndex.jpg

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I have great difficulty believing that with Kim Jong Un firing missiles on almost a weekly basis the dollar has much downside ahead. Just as the euro is near its resistance level at $1.20, the U.S. Dollar Index is near its support around 92 to 93. I don't see more dollar downside but I do see a lot of upside if Kim Jong Un gets what he deserves, which is elimination of his nuclear capabilities. If there ever was a case for a preemptive strike, which arguably is a highly controversial subject, it was not Iraq, but it is North Korea.

Subdued Volatility Ready to Surge

The S&P Volatility Index (VIX) - a formula for the weighted average price for the implied volatility of the S&P 500 Index - is near historic lows, but "implied volatility" is not the same as realized volatility. Implied means "priced into the future" (in terms of near-the-money options), while "realized volatility" means what has already happened.

CBOE-VolatilityIndex.jpg

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The VIX index is a fear gauge, in which more expensive options mean more volatility is expected in the future by investors. With September being the only month over the last 50 years (on average) that has expected negative returns (the second worst being February), I think the VIX is set up for a surge.

Traders say that "news breaks with the cycles" meaning that a market that is leaning one way will always find a news "excuse" to do what it was going to do anyway. Going after Kim Jong Un would seem like the perfect excuse for the VIX to surge.

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