What the VIX Could Be Trying to Tell Us

The QQQ, RUT, and SPX all have insulation at key percentage levels

Senior Vice President of Research
Mar 1, 2021 at 8:55 AM
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Last week, I was cautioning that the pattern playing out in the VIX was like last year’s, with respect to the VIX moving above prior resistance at its 252-day moving average. In 2020, the move above the 252-day moving average foreshadowed the massive volatility pop and stock drop that followed weeks later. To a degree, this pattern is still repeating, as the move above the VIX’s 252-day moving average two weeks ago was followed by a move back below it last week, which occurred last year as well…Whether the huge advance in the VIX two weeks ago is a bad omen for market bulls remains to be seen. The only certainty is that if you are interested in hedging with equity index, or exchange-traded fund options, it is much cheaper now relative to just one week ago.

          - Monday Morning Outlook, Feb. 8, 2021

The Cboe Market Volatility Index (VIX) closed below 20 last week for the first time in almost a year…There have only been five other occasions when the VIX spent at least six-straight months above 20. The table below shows each time the index fell below that level after those streaks. The last occurrence came at the end of 2009, as stocks recovered from the financial crisis. The S&P 500 Index (SPX) chopped around after this, with the index up over 4% after three months but down almost 4% after six months.

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          - Indicator of the Week, Feb. 17, 2021

With the equity market continuing to post all-time highs until the middle of February, a couple of our weekly commentaries since Feb. 8 have made observations about how the actions in the Cboe Volatility Index (VIX - 27.95) were intended to give bulls at least some pause with respect to potential market risks.

In fact, combined with other indicators -- such as the optimism among equity option buyers that typically occurs prior to corrective moves, as well as the S&P 500 Index (SPX - 3,811.15) trading closer to the top of a channel in place since mid-November -- comments in this space suggested either de-risking in terms of dollars allocated to the market, or at the time hedging via inexpensive equity index and exchange-traded fund (ETF) puts. 

While the lower boundary of channel support has also risen slightly relative to last week’s 3,810-3,825 range, there is still more downside potential for the SPX to the 3,830-3,850 area, which defines the lower channel this week. And if the SPX were to break below channel support, the rising 50-day moving average -- which marked its late-January low -- sits at 3,790, or 34 points above the benchmark's 2020 close, which may act as another area of support.

          - Monday Morning Outlook, Feb. 22, 2021

Such observations, particularly when it comes to VIX behavior, proved timely on the heels of Thursday’s 35% surge in the VIX. Amid this volatility spike, the SPX was sharply lower, and once again visited the bottom of its three-month channel, as well as its 50-day moving average for the second time in the past month. From a technical perspective, the SPX’s end-of-month pullback mirrors the late-January selloff, as you can see on the chart below.

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Separately, popular large-cap technology ETF Invesco Trust Series (QQQ - 314.14) pulled back to its December 2020 close around the $313 area for the second time since late January. Whereas this year-to-date breakeven level coincided with its 40-day moving average in January, this time it was the 80-day moving average that was aligned with its 2020 close -- a trendline that held at the September 2020 trough.

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I have been bullish on small-caps stocks, and they were not insulated from last week’s selling. However, like the QQQ, the pullback was contained at key year-to-date percentage levels that coincide with a moving average. In the chart below, note that the low was at the Russell 2000 Index’s (RUT - 2,201.05) 40-day moving average, which coincides with the round 10% year-to-date gain, or 2,175 -- a level that acted as resistance in January. For what it is worth, 2,175 is 50% above the key September 2020 closing low at 1,450.

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Schaeffer’s Quantitative Analyst Chris Prybal researched the historical SPX implications following one-day VIX moves of 35% or more, to ascertain what the VIX’s behavior might be telling us about future SPX behavior. The table below summarizes instances in which the VIX experienced a one-day move of 35% or more, and what that meant for the SPX in the days that followed.

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The odds favor a short-term buying opportunity. However, what stood out to me is that in the rare instances that bullish action did not follow a single-day VIX pop of 35% or more, the SPX’s declines on average were significant. In other words, while the odds of a significant decline from Friday’s close are low, they are still higher than normal. Moreover, one should note that the average declines following a sharp one-day move higher in the VIX are noticeably higher, relative to the expected advances.

This suggests that if you are using the pullback to act on bullish set-ups, it is a good idea to use call options to limit dollars at risk, should the market take an additional tumble in the short-term. If the support levels discussed above begin to break down, you should be more open to subsequent bearish action.

If the SPX moves higher to its historical average of 4.2%, following a one-day VIX spike of 35% or more, it will be trading just below the 4,000-millenium mark at the end of this month. On the other hand, using history as a guide, there is only a one-in-five chance that the SPX is 9% lower at the end of March. Such a move would push the index to the 3,480-3,500 area. 

While the VIX experienced a notable pop towards the end of last week, its 252-day moving average -- which equates to roughly one year -- acted as resistance in Thursday’s and Friday’s sessions. This moving average marked short-term VIX peaks in December 2019, January 2020, December 2020 and January 2021.

If the VIX closes above this trendline, which is situated at 30.50, the risk of further damage to equities increases in the short term. For instance, note in both February and October 2020 (circled in the graph below) that after the VIX moved back above its 252-day moving average, shortly after rising above and falling back below it, it eventually took out its most recent high. 

With last month’s closing high at 37.21, another close above its 252-day moving average could increase the risk of a short-term VIX move to at least the 40 area, or its October 2020 high. This is on the heels of a potential “warning shot,” when the VIX moved above its 252-day moving average in late January. In the graph below, note that there has been a VIX “floor” in place since November, at half its October closing high. 

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I plan to use Twitter this week to comment on recent option activity regarding iShares Russell 2000 (IWM - 218.31) and Nasdaq-100 (NDX - 12,909.44) components. Moreover, I will display updated charts on the short covering on QQQ, IWM and SPX components in the second half of January. This may not be a surprise, after media attention was turned to the massive short-covering that created monster rallies in some highly-shorted stocks, such as GameStop (GME).   

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

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