Schaeffer's Trading Floor Blog

Churn Baby Churn …

Why the market could be range-bound for the next few months

by 4/27/2014 7:23 PM
Stocks quoted in this article:

…SPY-co Inferno.

I'd like to go back in time and make a 2014 New Year's resolution to sell S&P 500 Index (SPX) or SPDR S&P 500 ETF Trust (SPY) strangles, ignore the day-to-day noise, and just roll the strangles every two to three weeks or so.

Net-net, Big Cap just continues to go absolutely nowhere. SPY ended the week of April 17 at $186.39 and closed Friday at … $186.29! It rallied nicely Tuesday, then gave it all back on Friday.

Meanwhile, 10-day realized volatility (RV) in the SPX continues to taper down. It peaked as high as 17.7 a couple of weeks ago, now it's back down to near 10 and falling.

With realized volatility trending down and the market itself making a net move to nowhere, the CBOE Market Volatility Index (VIX) should crash, right? Or at least trickle lower. But it actually lifted this week from 13.36 to 14.06. Go figure.

Well, it makes some degree of sense. The close on April 17 was ahead of a long holiday weekend, so perhaps that wasn't the "real" VIX. Rather, it was the "I don't want to pay for three days of options decay" VIX. Contrast this with last Friday's, "I better buy some Putin Protection" VIX, and it was more about the frame of mind heading into the weekend(s) than anything else.

Besides, it's not like 14 VIX is ever a moonshot. Over the course of forever, VIX tends to carry about a four-point premium to realized volatility, and that's exactly where it went out Friday, so it's not at all fat by that metric either. I'd venture to call VIX as close to appropriate value as it can get.

Our very good friend iPath S&P 500 VIX Short-Term Futures ETN (VXX) doesn't have holiday and weekend quirks like VIX. And it also doesn't react as much to modest upticks in fear, like our bi-weekly Putin scares. VXX perpetually prices in that something's going to happen to lift volatility sometime soon. VXX lifted all of 0.12 point last week. We're now up to 66 trading days without a new all-time low! One day more and we tie the third-longest streak EVER! Flight to Quality … or at least Lack Of Flight Out of Mathematically Challenged Convoluted Derivative!

Every week I think that this never-ending range-bound trade will end. It can't possible be right to fade every single little market move. Surely someone will get majorly squeezed. And yet, it never happens. Memorial Day isn't so far away, and then we have the notoriously slow and non-volatile summer trade. So if we don't get some excitement soon, do we just stay basically here for a few more months? Sure seems that way.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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