Here is an update.

At the time of the prior post, the forecast was for an upside potential price of  $54.47 (+4.1%) and a downside of $49.39 (-5.6%).  Its history, following 394 prior forecasts of like proportions, was that closing prices higher than the forecast day’s closing price (then $52.32 ) happened 46% of the time, with average gains of +5.4%, and lower prices were seen the other 54% of days in the next 3 months, falling an average -6.8%, with largest losses typically running -9.6%.

Not a particularly exciting moment in the life of XBI, but we simply wanted to brag about a good past history of identifying price extremes.

During the past month XBI has in fact declined, in sympathy with the market, to $46.61, off by -11%, on October 28.  The forecast at that point was a high of $51.52 (+10.5%) and a downside of $46.48 (-0.3%).  The odds for higher vs. lower prices then were 3 : 1, with 75% of the days in the next 3 months following 53 similar prior forecasts averaging gains of +8.3%.  Loss days averaged -4.5%.

In our book, these are attractive proportions, indicating XBI should be bought at that time.

It has turned out well.  By November 16 XBI rose to $51.31, and today, the 17th, passed the $51.52 upside target on an intraday basis.  Our practice is to close out such a position and look for ways to re-employ the capital, including the +10.5% gain.  It took 13 days, better than the usual 40 or so.

Unless you are skilled in options trading, the VIX may only be a curiosity.

Now there are both VIX futures (CBOE/FCE) and a VIX-related ETN (VXX) available to play with. Don Fishback has just written a very good Graham&Dodd analysis of the VXX at Seeking Alpha that should discourage anyone from exploring that ETN with real money.

Especially those who learned that, no matter how smart you think you are, investing in things you don’t really understand can be detrimental to everyone’s economy, including yours.

What is not often recognized by casual observers is that the VIX itself has options that can be traded. Skilled options traders usually employ them to get big leverage advantages when they are convinced a directional play in the market is at hand.

The VIX tends to be a contra indicator, being low when markets have built up strong advances and everything looks too good to go wrong … go wrong … go wrong, and then jumps up high when it does and no one seems to know where the bottom will be.

For a long time the VIX seemed to range over a span of 10 at the low end to 40 at its tops, with 20 or so sort of a central tendency. But then came last year’s September Crisis and the VIX rocketed to 80.

As things struggled to get back to normal the VIX hovered between 40 and 60 until the notion became accepted that perhaps a bottom had been reached in March. Since then the VIX has gradually been working its way down to between 20 and 40.

But as that has been going on, and particularly of late, the market has been undergoing short spasms of decline and recovery. One currently is in progress. The last 4 days has seen the VIX jump from 20 to 28, a 40% advance. Some VIX options are up +100% or more. The S&P500, or SPX, has declined by -4 1/2%.

Wouldn’t it be great to know when to get aboard that kind of a ride?

This is speculation, not investing. But because there seems always to be an appetite for such gambles, I’ll let you in on what we find in looking at how the options pro traders are behaving.

The analysis is the same as what we use to identify the expectations of the big volume market makers in stocks. Here the players are a different bunch, with very different tempraments and behavior limits. But they are driven to operate from the same set of logical rules while seeking low-risk, high-probability profits.

The accompanying chart shows what the options pros must believe could (not will) happen to the VIX’s price in the near future — two weeks to two months. The green days are where the expectations range is virtually all higher than the heavy dots that mark the end-of-day values for the VIX.

On a short-term basis the VIX typically moves contrary to the SPX. Under the right extreme circumstances expectations for changes in the VIX can point to changes in the S&P500. Here is a picture of how nearby SPX moves relate to where VIX expectations are in terms of its present price. (The VIX metric is like a stochastic, but uses our derived forecasts rather than backward-looking price history.)

Draw your own conclusions.

Despite the fact that it doesn’t seem to be getting either more Swine Flue vaccine on the scene or more mortgage or small business credit available, the trillion-dollar pace of deficit persists.

Perish the idea that it be called inflation, but prices of many things keep going up, including ETFs denominated in dollars.

Expectations of market-makers for ETFs holding either precious metals or stocks of companies that mine the stuff are on the rise, too. That makes several ETFs attractive, odds-on buys at this point.

Most appealing is IAU, the COMEX Gold Trust i-Shares, where volume market-makers see the potential for upside gain of over +10% in the next 3 months, compared to a downside exposure of less than one-quarter of that. Their batting average has been very good, with higher prices following forecasts like the present 78% of the time.

Silver may have an even bigger kick, with SLV, the Silver Trust i-Shares priced to provide an upside of almost +15% in that same time, at an exposure of some -6%. The scorecard here is not as overwhelming, but higher prices 71% of the time after such forecasts is not bad.

Even better odds and bigger price move potentials are present in AGQ, the Proshares Ultra Silver ETF that has (2x) leverage engineered into its holdings structure. There prices have been higher 75% of the time, given current day forecasts, and by 27%, on average. The forecast is only for 23% gains. But leverage has its downside, where the encounter could run to -10%, instead of only half as much at SLV.

The parallel ETF play to the dollar’s continuing debasement lies in TBT, whose (2x) internal leverage magnifies the short position it provides in 20-year US Treasury bonds. At a price of $47.89 its forecast of $54.37 indicates a possible gain of +13% with an exposure of only -5.5%

All of these ETFs have better Reward-to-Risk scores than 94% of the 2,000 other equity securities we cover. But don’t take too long to decide, their prices are constantly in motion.

Our principal interest is in identifying specific investment opportunities, not having market environment discussions. Still, with a backdrop of over 5 million price range forecasts, the potential for useful information exists.

But that overall equity market is subject to such a diversity of influences and changing circumstances, getting any useful handle on it is a task beyond nearly everyone, including us and our sources – who may be the best informed players in the business.

Instead, we prefer to find time-disciplined, defined-size, price swing situations in specific investments that have evidence of fairly reliable prior forecasts. We limit ourselves to time horizons that have reasonable chance to be foreseen, usually 3-6 months.

We get our forecasts from the way that market professionals protect themselves as they compete by taking necessary at-risk positions in stocks and ETFs. Their hedging activities are committed, forward-looking forecasts of what they believe can happen.

Here is a picture of how they saw prospects for XBI, the S&P Biotech SPDR, during the past two years:

In this chart the vertical lines are forecasts of prices to come, not records of prices past. The colors suggest investment traffic signals available at the time.

A simple, but useful guide is to consider the range top of a forecast as a sell target for a buy made at that date. The target should be kept specific to the buy, and not changed, despite subsequent events.

You say that’s not the way it’s done? Not what you’ve been taught?

Suppose you chose to buy the XBI in early April, 2008 at $50 because the biotech industry’s future then looked very bright. Damn! Were you smart – for a while.

Doing what you were taught, you held it for the “long term.” Maybe not so smart. Because here you are a year and a half later at $52 with only a 3% annual rate of gain.

Using the traffic signals instead, and reading rough estimates from the chart, you could have had (April’08)Buy@50-Sell@60, (October’08)Buy@50-Sell@57, (March’09)Buy@43-Sell@51 for gains of $10, $7, and $8; $25 instead of $2. And have had your capital available for other use perhaps 1/3^rd of the time.

With no sickening lose-a-third-of-your-money drops from $69 to $43.

This is shorter time horizon active investing, not day trading. You would have made three transactions in a year and a half, not an hour and a half. Holding periods averaged four months, not four hours — or four years.

The market-makers don’t want or intend to hold any position four months. But they can probably anticipate most of the price-moving conditions in the next 3 or 4 months. They just don’t know for sure when any of them might occur. So their uncertainty has to include them all, even if their positions are eliminated in 4 days.

Just try and anticipate what any company is likely to really earn in 4 years, let alone what their capital structure (number of shares) may be and what their auditors will allow them to report. And correctly guess what the market conditions will be like out there in time, and you might know what your return on investment will be.

Duplicate that effort for all of the candidates you might speculate in so that comparisons can be made, and, voila, you’re a long-term investor (?).

There’s a reason that America’s Cup sailboat skippers sail all those short tacks. That way the competition doesn’t get away from them if the wind shifts temporarily in their favor.

We derive forecasts from the hedging actions of the block trading community on over 2,000 widely-held and actively-traded stocks, ADRs, and ETFs. The common denominators of upside and downside price move potentials are present in all of the forecasts. The uncertainty involved in each is indicated by combining the up and down.

Those common denominators let us aggregate expectation descriptors for the equity market as a whole, or for any subset of interest. To put the overall market in a picture many stock investors can relate to, we took the recent price history of the S&P500 index, and expanded it to embrace the daily average upside and downside expectations of our entire population.

What appears immediately is the way fears and hopes expand the range of expectations when the market is rapidly and substantially declining. Less obvious, but also present is the “What, me worry?” attitude of investors in rising markets. Then the range of uncertainty shrinks.

These effects are more apparent in the following picture:

In the 2008 May-July market decline downside concerns widened only a bit, while upside hopes stayed high. Those hopes were modestly rewarded by a market rally into September. But as declines began again the downside apprehensions expanded and then mushroomed into a panic, along with plunging prices.

The convictions of optimists are hard to kill off, fortunately, so upside potentials widened appropriately for many stocks, expanding that dimension’s average.

While the market stabilized as year-end approached, the downside fears subsided back to earlier levels. But more bad news lay ahead, and further market declines into early March of this year repeated prior investor responses. Still, they were not as extreme as before.

Nor were they in early July as a month’s worth of declining market index numbers tested investors’ convictions. Then downside expectations did not expand much, and the market rejoined the recovery path.

Now the question turns to can it continue? Is it “what, me worry?” time?

That attitude may have started to appear in early September when downside concerns greatly diminished. They were accompanied by reduced upside convictions, and the level of blue-line uncertainty dropped to a level not seen in over a year.

The following couple of weeks’ pullback shook off the complacency, and once more the raised levels of concern were less severe on the downside than previously. But so were the enthusiasms of the upside. Yet uncertainty remains in a healthy range.

Looking back at the first chart, the S&P500 index price continues to be accompanied by upward trending lows and solid to up-trending highs. Behavior of the lows is most encouraging. Our conclusion is that the overall recovery continues, showing no signs that investors are likely to precipitate a serious downturn, absent the introduction of some new momentous disruptive event.

That appears to be a direct parallel as block traders are hedging their at-risk positions when filling trades in SPY, the S&P 500 SPDR. Their current forecasts are for a range of $104 to $118, +8 ½% on the upside, and – 4 ½% on the downside.

Over the past five years 129 forecasts with similar upside to downside proportions, or better, have seen higher SPY prices in 2/3rds of the days of the following 3 months, averaging +16%, and lower prices in the other 1/3^rd, averaging -14%. Buy and 3-month hold gains outweighed losses 1.9 to 1. SPY now ranks better on a reward-to-risk scale than 74% of the 2,000+ issues we follow.

Peter Way Associates has no present investments in SPY.

Where there is volume, SKF the leveraged (2x) inverse (short) of financial stocks is their best odds-on play, but it’s a modest chance (65-35 odds) on a big gain (21%) that might include a -12% drawdown from cost along the way.

Not what you’re looking for?  Next best bet of the moment (with market liquidity) is SLV, i-Shares in silver.  They offer about the same odds with less volatility (+10%, -6%) and about half the odds-on payoff experience of SKF.  It falls just under our minimum return hurdle of 5% in 3 months.

Now if you’re willing to work in something that typically only trades 200,000 shares a day, then IAU, the COMEX gold iShares may appeal.  They present a very high odds for a +10% 3-month gain with only a -1% downside history.  Here history is the rub.  These ETFs have only 9 months of trading for us to track, and only a dozen days with forecasts as good as today’s.  Evolving experience may not be as favorable.

An alternative in the less-liquid-trading camp at this date is PIN, the Powershares India ETF.  More history for us to work from (year and a half) but it is back to the mediocre gain-loss odds (63-37) for big potential price swings (+23%, -12%), like SKF.

Sorry, but right now there are no stamp-your-foot, pound-on-the-table screaming buy opportunities.  Better to keep your powder dry.  Check in tomorrow or later in the week, and we’ll see if something better appears.

The bears are on the prowl during this mid-vacation-season.

While the second team is in charge, trading volume of all stocks typically declines a bit. Yesterday it ran about 4.4 billion shares on the NYSE, AMEX, NASDAQ, and regional exchanges. ETF volume, on some days over 50% of the total, was down to 30%, at 1.3 billion shares.

The lower volume encourages some players to stick around during a time when their activity can have a more pronounced market effect. Trading of leveraged and short ETFs gives us a look at what they may be up to.

At yesterday’s prices, all ETFs traded over $58 billion, down from a prior 3-month daily average of $68 billion, a decline of -15%. Over 9/10^ths of the usual $68 billion is in 76 ETFs that normally trade over $100 million a day. Over 3/4^ths of the action is in two dozen ETFs that each trade over $ ½ billion daily.

Over $9 billion of trades were in inverse, or short-positioned ETFs, with less than $6 billion in leveraged long ETFs.

High rollers like the 3x action of the FAS (leveraged long) and the FAZ (levered short).

While trading in the FAS edged off less than ¼ of 1%, volume in the FAZ doubled.

FAS is trading near the middle of its past 52-week range, while FAZ is near its low.

A quick check of all the inverse, or short-position ETFs among the most actives shows that they too are trading near or at their lows.

They may not stay there when the first team returns.

Poor Goldman Sachs, they had two trading days last calendar quarter when they LOST money!

When you learn that in 46 of the other 63 days they made over $100 million each day, it is clear that they aren’t taking unnecessary risks. In fact, very few risks at all.

The art form is called hedging, or arbitrage. During the quarter 78% of their profits came from the proprietary trading desk, where it is actively practiced.

These days hedging is made easier by the availability of highly liquid, easily tradable Exchange Traded Funds (ETFs). On Friday over 1.8 billion shares of them were traded, out of a total of 3.5 billion shares between the NYSE and NASDAQ.

That’s right, over half of the trading volume was in ETFs. I wonder who’s doing it. I didn’t trade any 18 million shares (just 1%) on Friday. Did you?

That ETF volume was at an average of $40 a share, worth $73 billion. And this is in the heart of the summer vacation season, when activity is pretty quiet.

Now, if Goldman Sachs made another $100 million on Friday, their vig on just the trading value in ETFs was only 14 basis points, 1/7^th of one percent. Pretty small.

But they don’t do all the trading in ETFs, they have the company of Morgan Stanley, Mother Merrill, Citi, and others.

Hedging these days is made much easier for us common folk by the availability of ETFs that are engineered so that long positions are the same as being short an index, or whatever the ETF is tracking. No margin account is needed, nor any pledge of capital or impairment of borrowing capacity. Just an ordinary cash account at the broker.

Further, many of the short, or inverse ETFs also have a built-in leverage that magnifies the price moves by either two or three. Again, they’re available without any of the usual broker or bank borrowing encumbrances.

These are popular vehicles for risk management. ProShares, the largest provider of leveraged and inverse ETFs, saw $9 billion of trading in their products, just on Friday. With all that activity, perhaps something can be learned by checking out whether there is more enthusiasm for leveraged short ETFs or for leveraged longs.

Here are the upside and downside forecasts of the prop desks and block desks for both sets of ETFs. Any items above the diagonal dotted line have larger downside prospects than upside.

The Market Thermometers page can be accessed directly from the home page by clicking on the underlined Index Forecasts>> link. Some readers have taken to bookmarking the page on their browser for easy daily access.

It shows what the community of institutional investment strategists must collectively believe could happen to the prices of four major market indexes over the next few months. If their thinking was otherwise, they would be willing to pay different prices to hedge their at-risk exposures in each index.

Covered are the 30 Dow-Jones Industrials (DJIA), the S&P 500 (SPX), the Russell Small-cap 2000 (RUT) and the Nasdaq 100 (NDX). All are institutional benchmarks.

Before ETFs were available it was difficult, but possible, to invest in these indexes. Still, the price insurance markets of listed options in each of them have existed for decades.

We have used some of those evidences of intent since the ‘70s and ‘80s. They come from the investment industry’s best informed and most sophisticated professionals.

What you see in the display is the range of prices for each index that the pros believe are necessary to be protected against; prices that could be encountered under reasonable circumstances. Their high and low limits are arrayed across the top and bottom of the picture.

The red “temperature” column top marks where the index’s current price stands in that range. The higher in the range, the hotter the market action is currently. By implication, then more downside exposure exists.

In the center of the display is a vertical scale of Reward vs. Risk, where Risk refers only to market price risk, or downside threat. The scale is arbitrarily limited to ( 1 : 100 ) and ( 100 : 1 ).

While specific securities from time to time encounter prices that exceed their current forecast limits, this very rarely happens to indexes that are averages of dozens to thousands of stocks.

For the S&P500 the range of experiences across 20+ years is at its cheapest when ten times as much upside as downside is seen ( 10 : 1 ) . It is at its most expensive when three times as much downside as upside is expected, a ratio of ( 1 : 3 ).

The average reward to risk relationship for broad market indexes, as well as for all stocks, is slightly below ( 1 : 1 ), reflecting that investors generally prefer to sacrifice some return opportunity in order to avoid loss. Logically, when downside price prospects are larger than upside ones, the investor is taking on more potential problem than promise.

So when looking at the thermometers it is reasonable to regard markets as getting overheated when the red columns get above the ( 1 : 1 ) level.

That thinking holds true as long as equity investments are being driven by a value mentality. But not all stocks are priced that way. Some are dominated by a momentum notion.

This is particularly true in high growth technology stocks of the type that are prevalent in the Nasdaq 100 (NDX) index. So in that thermometer it is not at all alarming to see the mercury riding in the upper half of its tube.

Conversely, the NDX may see prices low in its forecast range as its constituent stocks decline rapidly in price. Instead of signaling bargains, this often presages continued falling prices.

This difference between value thinking and momentum ideas is why we always consult our actuarial tables of specific stock odds and payoffs when contemplating investment actions. But more on this point another time.

Before, the blog was intended to explain why our philosophy and approach was what it is. We sought to inform, educate, and provide big-picture perspective. We will continue to do that in a separate blog channel set apart for that purpose. It will see periodic entries.

But now our primary blog activity will focus on items of more immediate impact, where timely attention may help you fatten up the P side of your P&L. There may be more than one a week, possibly even more than one in a day particularly well endowed with opportunity.

We will continue to have a particular focus on how professional investors and their organizations utilize Exchange Traded Funds (ETFs) to manage their risk exposures.

That will often involve looking closely at the evolving activities in ETFs that are built to go up when the prices of their holdings go down (inverse, or short ETFs) and the use of ETFs that have the price movement accentuation of leverage as a part of their internal architecture.

On top of all that, our everyday updates of the price range prospects for actively-traded ETFs will continue to provide opportunity for comment as changes occur. And the market thermometers showing the coming-weeks’ price range potentials for the four major market indexes will be present each day.

If you want to be a player, instead of finding yourself played with, check in here regularly.