Good News for Bulls from VIX Futures Players

Recent market strength, promising seasonality trends, and a lack of volatility could have bulls cheering through the holiday season

Senior Vice President of Research
Nov 30, 2015 at 9:49 AM
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"... the 'obvious' risk to all technicians is this year's resistance immediately overhead… the SPDR S&P 500 ETF's (SPY - 209.31) rejection at the 210 strike, where heavy November call open interest resided… was likely driven by November option mechanics, as this open interest was mainly seller-generated, according to data that we receive from the exchanges. Without getting into the details as to why, trust that 'capping' action tends to occur when an underlying approaches a call-heavy strike in which the calls are seller-initiated... risk in immediate term that Friday's gap higher is filled."

--Monday Morning Outlook, November 23, 2015

On Monday of last week's holiday-shortened trading, the SPDR S&P 500 ETF (SPY – 209.56) indeed filled the upside gap created during the previous Friday's trading. Buyers quickly came in when the gap was filled, leading to a strong Monday final-hour close. Things quickly changed Tuesday morning, following overnight news of Turkey downing a Russian airliner. The SPY gapped below the prior day's low, and the threat of a bearish "island reversal" (created by the previous Friday's gap higher and the Tuesday morning gap lower) materialized. Such action must have had some bears feeling good, as there was the potential for a bearish "island reversal" pattern occurring just below the SPY 210 area, which has been a lid in 2015. However, by Tuesday's close, the SPY staged an impressive reversal, and the "island reversal" pattern never materialized. The SPY preceded to move sideways into Thanksgiving at the previous week's close in the $209.30 area, and Tuesday's and Wednesday's highs served as resistance in Friday's trading.

While stocks didn't make a lot of headway last week, by some counts last week's action might be viewed as a victory for bulls, as bears must have been frustrated by the fact that growing instability in the Middle East and a morning sell-off from obvious chart resistance was not enough to knock the market visibly off course.


"For bulls, the encouraging news is that a pattern we have seen from time to time preceding a breakout is a pullback from chart resistance that is supported by an intermediate-term moving average…The continued unwinding of the extremes in negative sentiment from weeks ago is supportive of such a scenario… the sentiment backdrop and some technical measures suggests an increasing probability of an SPX breakout, with strong seasonality serving as a reinforcement."

--Monday Morning Outlook, November 23, 2015

As seen above, in last week's commentary we discussed the heightened probability of a SPY breakout above the resistance levels that lie just overhead. This forecast is based on a SPY technical pattern we have observed ahead of some breakouts, combined with the continued unwinding of an extremely pessimistic extreme several weeks ago and strong seasonality providing another tailwind. We did not detail relevant seasonality statistics, so therefore we will share a couple seasonal notes of interest this morning.

First, most of you are likely aware that December has been historically strong for the stock market. Per the table below, it shares the highest winning percentage with April and November looking back over the past 20 years. Moreover, it is one of only five months that averages a return of more than 1% and is the least volatile, as measured by the standard deviation of returns.


"Over the last 65 years, the S&P 500 has averaged a gain of 2% from Thanksgiving to the end of the year, according to Jeffrey Hirsch, editor of Stock Trader's Almanac. The index has been higher about 70% of the time, rising in 46 of those 65 periods. Performance for the large-cap S&P index deteriorates though when it ends the Wednesday before Thanksgiving down for the year."

--The Wall Street Journal, November 25, 2015

Second, we found the observation by Mr. Hirsch, found last week in The Wall Street Journal, interesting too. We did our own research on this to give you a little more insight as to what he found.

Essentially, whether the S&P 500 Index (SPX – 2,090.11) is positive or negative year-to-date (YTD), the average positive return tends to be twice that of the average negative return, with the odds of the SPX rallying from Thanksgiving into year-end better than 60%, no matter if the SPX is positive or negative YTD.

What stands out to us is that absolute moves from Thanksgiving into year-end tend to be bigger when the SPX is negative YTD going into Thanksgiving. This is apparent in the comparison of the average positive and negative returns, in addition to the standard deviation of returns. Regardless, bulls should find favorable the near-75% chance that the SPX moves higher into the end of 2015, given last Wednesday's SPX close above 2,058.90. Also of interest is the lower standard deviation of returns around its average return of 2.05%.


Speaking of standard deviation and volatility -- back in late August, I observed that the CBOE Market Volatility Index (VIX – 15.12) futures players had moved into a rare net-long position. When they did this in October 2014, it marked a significant market bottom and peak in volatility. Looking back, they did it again, as VIX futures have moved significantly lower since their late-August peak. These participants continue to be excellent contrarian indicators, as they were also in an extreme short position in late July, just as volatility was about to pop significantly higher.

At present, VIX futures players are far from an extreme in their typical net short position. This may have bullish implications for stocks, as this relatively small net-short position in VIX futures could be a sign of lower volatility ahead following the rare move into a net-long position, and this is consistent with our bullish outlook into year end.


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