Schaeffer's Trading Floor Blog

The End of the Rally is Upon Us ... Or Is It?

Why the CBOE Volatility Index (VIX) bounce isn't necessarily reason to panic

by 7/9/2014 7:46 AM
Stocks quoted in this article:

Is this the beginning of the End of The Rally?

Short answer is … c'mon, who can possibly make a judgment on that without the benefit of hindsight?

Longer answer is … you really shouldn't aspire to catch THE top. I'd rather either sell gradually into rallies over time, or sell after we've started to pull back. Let pundits on TV make the dramatic calls. The reality is, if I'm picking one spot and selling into strength, there's about a 0% chance I picked the right spot.

Even longer answer is … well, let's look and see what clues we have in the volatility indices, because that's what we do here.

The CBOE Volatility Index (VIX) has rallied 20% off the lows! And it took just two trading days!

That, of course, sounds way more impressive than saying that the VIX lifted 2 points off 7.5-year lows. And we hit those 7.5-year lows for a couple of very good reasons. One is that realized volatility in the S&P 500 Index (SPX) was only about 5 or 6. Another is that the low came right before a long weekend, which tends to understate "real" volatility assumptions.

Also, a full week of 12 VIX isn't going to ever fit anyone's definition of overbought and panic-stricken. We're all the way back to where we sat about two weeks ago.

What's more, my friend in the VIX pit tells me of this play:

VIX- Barclays buys 144k July 13p to sell July 16/20 cs .82

In English, that means that Barclays bought near-the-money puts vs. selling an out-of-the-money call spread, and paid 82 cents for the combo. That's a decent-sized bearish bet on the VIX.

So, hey, if you're rooting for an end to the rally, that's kind of what you want to see -- disbelief from the volatility crowd.

Unfortunately (or fortunately), the VIX itself is a pretty narrow look at sentiment. VIX futures traders as a whole are still pricing in a VIX rally. Here's the term structure as of yesterday morning (click chart to enlarge):

VIX Future Term Structure since July 2013

The song remains the same here, always. That VIX rally "tomorrow" remains forever anticipated.

And VIX remains the Dog of the Volatility Indices. The CBOE Russell 2000 Volatility Index (RVX), which tracks Russell 2000 Index (RUT) volatility, is back to all-time (back to 2007) highs vs. the VIX. The RVX itself is back to 19, off recent lows in the mid-15s, thanks to the return of MoMo selling.

Throw it all together, and I think there's a little something for everyone to hang their hat on. Many of these sell-offs look scary at first … but so far, they've all petered out fairly quickly. I'm really not ready to form a big opinion on this one just yet. Or even a little opinion. It's two days of modest selling off record highs.

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

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