The Fascination Behind Current Market Volatility Expectations

The Nasdaq-100 Index (NDX) should give investors pause amid continued technical deterioration

Senior Vice President of Research
Mar 7, 2022 at 8:50 AM
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… on my radar is the recent return of Cboe Volatility Index (VIX — 27.75) futures options buyers. The 10-day buy-to-open call/put volume ratio is approaching 2.0 again…when this ratio gets to or above this level, higher volatility and lower equity prices usually follow.”

            - Monday Morning Outlook, Feb. 22, 2022

Despite the added uncertainty related to the Russian invasion of Ukraine, as previously high commodity prices burst even higher amid the conflict, I find the action in equity market volatility expectations fascinating from a couple of perspectives.

First, note that the Cboe Market Volatility Index (VIX -- 31.98), while trading at sustained higher levels than we have been accustomed to experiencing, has been capped around its November high. This level is in the vicinity of double 2021’s close and this year’s closing low. Since late-January headlines that a Russian invasion of Ukraine was imminent (and the invasion has since occurred), the VIX has tended to peak at these key levels. A late day move or close above this area would cause for concern for bulls.

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The second observation regarding volatility expectations is that call buying relative to put buying on VIX futures was ramped higher just days before the VIX’s January peak. However, the 10-day ratio of VIX futures call buying relative to put buying never touched that “magical” 2.0 level that has tended to precede higher volatility. In fact, since my Feb. 22 observation pertaining to the action of VIX futures option buyers, the call/put volume ratio has declined, which could mean that the highs we have seen in this index are what we could expect to see in the days ahead.

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Federal Reserve Chairman Jerome Powell’s comments last week, in which he all but assured market participants that a 25-basis point hike in the fed funds rate would occur when the Federal Open Market Committee (FOMC) meets March 15-16, likely support the case for a VIX ceiling being established. His comments removed some uncertainty as to the size of the coming rate hike. Such uncertainty related to the Fed’s next move at the March meeting likely took some bite out of the current VIX reading. But the conflict in Eastern Europe still leaves questions on how high and for how long multi-year record highs in inflation will persist, which will likely keep volatility expectation readings elevated around current levels.

If volatility expectations have limited upside, it likely means that some equity benchmarks could have limited downside, such as the S&P 500 Index (SPX -- 4,328.87), which continues to hold above the 4,289 level, or a round 10% below the 2021 close, and 4,300-century mark, which has been an area of multiple troughs since last July. The index’s 320-day moving average at 4,257 is another potential short-term support level.

At the same time, the top rail of a downward channel that defines potential resistance means limited upside, should sellers continue to surface on rallies into this trendline. Even further, this move has become more defined since the SPX’s peak two months ago. The top rail of this channel begins the week at 4,434 and will be at 4,397 at the close this Friday, which is also around the SPX’s highs last week.

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Hedge funds that make both bullish and bearish equity bets became big buyers of shares in individual companies in February for the first time in four months, prime broker data compiled by Goldman Sachs Group Inc. show. The amount of net purchases in single stocks reached the highest level in the past yearThose tracked by Goldman scooped up tech stocks at the fastest pace since December 2020, warming to an industry that caused them pain in January’s violent market rotation into shares that looked undervalued based on fundamentals.”

            - Bloomberg, March 2, 2022

But an equity benchmark that should give investors pause amid continued technical deterioration is the Nasdaq-100 Index (NDX -- 13,837.82). Despite hedge funds apparently scooping up technology-related shares, per the excerpt I saw in a Bloomberg news article last week, the index has failed to mount a serious rally amid the tailwinds from deep-pocketed hedge fund market participants.

In fact, the NDX closed below the round 14,000-millennium level last week, which is also double its 2020 closing low. The disappointing action in this index at last week’s close followed a failure earlier in the week to move back above its 320-day moving average, which was situated just below the October 2021 closing low. If you are still looking to de-risk in this environment, this area of the market should still be considered vulnerable, given its failure to hold above potential support levels amid hedge fund buying activity.

This article is somewhat supported by the action of equity option buyers during the past month. Put buying relative to call buying on components of the technology hardware & equipment/software & computer services sectors is barely above what has been considered normal readings since 2019. Given the massive rotation out of this group, it seems like more capitulation among investors might be needed.

Overall, many sentiment readings that we follow are showing extremes that have coincided with major market bottoms in the past. The sentiment backdrop is a risk for bears, but then again, major equity benchmarks must move above the resistance levels discussed above, to give the bears reason to move off the sidelines or cover short positions. 

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

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