Moving Averages Could Tell Us Another Volatility Pop is Coming

Prospects for vaccine candidates may be more important to investors than originally thought

Senior Vice President of Research
Oct 19, 2020 at 8:46 AM
facebook X logo linkedin

“… as potential election volatility continues to be a popular media theme, perhaps scaring many out of equities, there has been an interesting development is the Cboe Volatility Index’s (VIX—25.00) second consecutive close below its 252-day moving average on Friday. This occurred after it traded above this important moving average for all but one day since August 31st. The VIX also closed below its 30-day moving average, which I have been following closely…The bullish VIX signal was concurrent with the S&P 500 Index’s (SPX—3,477.13) close back above 3,400 and its February high, the Russell 2000 Index (RUT—1,637.55) close above 1,600 -- which acted as resistance in August and September…a contrarian play to the media’s higher election volatility theme would be to position for lower volatility and higher stock prices in the days before and after the election. If the VIX moves back above its 30-day and 252-day moving averages, all bets are off. ”

            - Monday Morning Outlook, October 12, 2020

Last week was a test for those playing pre-election and post-election rallies in equities, and betting on a concurrent decline in volatility. That is based on the Cboe Market Volatility Index (VIX -- 27.41) signal that I referred to in last Monday’s commentary.   

On Friday, the VIX closed north of its short-term 30-day moving average, and its longer-term 252-day, or one-year moving average. Both moving averages have provided guidance in forecasting volatility in recent months. But crosses above and below have been less meaningful this month. Monitor the VIX closely, as consecutive closes above these moving averages should put you on alert that higher volatility is ahead, contrary to my thinking from last week. A VIX close above the trendline connecting lower highs since mid-September could be used as a tool to confirm that higher volatility is imminent.  


In the meantime, the S&P 500 Index (SPX -- 3,483.81) was pushed back below the round 3,500 century mark, after closing above this level a few days prior. This mark is just shy of the 3,553 level that corresponds to a round 10-percent year-to-date gain for the index. Moreover, the Russell 2000 Index (RUT -- 1,633.81) closing high last week was at 1,649, just 19 points shy of its 2019 close at 1,668. This happened after the Invesco QQQ Trust Series (QQQ -- 288.51), which is heavily tech oriented, closed just south of the round $300 level last week.   

It appears the recovery in the stock market and the coincident VIX close at its Thursday low was hinting at a headline Friday morning that Pfizer (PFE) may file for emergency use of its developmental COVID-19 vaccine by the end of November. This suggests once again that prospects for a vaccine or remedy for the virus is more important to investors than immediate stimulus or the election. But that does not mean all future headlines with respect to a vaccine or remedy will be good, and that in turn would be the risk to investors.

On the sentiment front, there are a couple of discussion points worth noting, both of which are risks to the bulls. 

First, if you are wondering who is driving the market higher in recent weeks, it appears to be active investment managers. The table below displays the next exposure of these market participants, per the weekly National Association of Active Investment Managers (NAAIM) survey. Last Wednesday, the reading came in at 102.9 (a reading of 100.0 means fully invested and 200.0 is leveraged long). The last time this group was fully invested was mid-August, prior to the September pullback. If the SPX experiences a decisive close back below the February high of 3,386, it is likely that this group is reducing exposure ahead of the election. In August, this group was fully invested for three weeks before reducing exposure.


Plus, despite the media attention on the potential for election-related volatility, the chart below caught my attention. During the past 20 trading days, option buyers on VIX futures options have purchased more puts than calls. In other words, the bet is that volatility will head lower. This is extremely unusual because typically more calls are purchased than puts.

I am not entirely sure what to make of this. On one hand, extremes in VIX futures options call-buying have been "smart money." When this has occurred in the past, higher volatility followed, usually in the context of Large Speculators (dumb money) on VIX futures options being positioned for lower volatility. 

So, if the historically massive put-buying relative to call-buying on VIX futures options is viewed as "smart money," the indication at present would be that lower volatility is ahead. But I would rather see this activity occur in the context of dumb-money large speculators on VIX futures being positioned for higher volatility, which is not the case. With active investment managers now fully invested like they were in August, and net shorts on VIX futures now exceeding 100,000 contracts, the lower volatility bet might be getting too crowded. 

The idea is to have a short leash with respect to the lower volatility, higher equities trade. While this trade got off to a good start last Monday, it is not yet broken. But then again, it is not looking as promising either.   



Todd Salamone is Schaeffer's Senior V.P. of Research

Continue reading:



How to collect 1 dividend check every day for LIFE

Did you know you could collect 1 dividend check every day the market is open? You could also do it starting with just $605! For me, I'm collecting 70 dividend checks every quarter…which averages around 1.1 dividend checks every business day. There's no trading behind this... no penny stocks or high-risk investments. All you do is buy and hold and you're set. There's no set up required either. If you start buying the dividend stocks I show you today... you could collect 1 dividend per day starting as early as this week. Click here for all the details.