“… CBOE Volatility Index (VIX – 33.40) futures option buyers, who have had a solid track record the past few years in forecasting volatility expectations for equities, were hinting that volatility was heading higher, potentially putting the SPX’s mid-March breakout in jeopardy of being a fake-out move to the upside. These option buyers were again prescient with respect to their timing, with the VIX surging into the 30 area as the SPX closed back below the 4,375 level on April 22.”
- Monday Morning Outlook, May 1, 2022
“…the Cboe Market Volatility Index (VIX -- 30.19) closed last week below the 33.00-34.50 area that marks double 2021’s close and double this year’s closing low. This could pave the way to another short-term move to 25.00, or last week’s low and a round 50% above the 2022 closing low.”
- Monday Morning Outlook, May 8, 2022
Per the excerpts above, I have made observations on the Cboe Market Volatility Index (VIX -- 28.87), specifically referencing the smart money call activity on VIX futures that preceded the downturn in equities and the most recent VIX spike. Additionally, I have made readers aware of a zone of potential resistance on the VIX in the 33.00-34.50 area that represents double last year’s close and double this year’s closing low.
Admittedly, I am a bit perplexed how this resistance area managed to hold since late April, as the VIX stubbornly stayed in this zone as equities plunged. In other words, on April 26 the VIX closed at 33.52, with the highest close since that date occurring early last week at 34.75. Since the April 26 close, the S&P 500 Index (SPX -- 4,023.89), after a brief retest of the October 2021 and January 2022 lows, plunged roughly 6% into last week’s closing low. As mentioned above, the VIX made very little upside movement during this period and, in fact, closed at 28.87 last week below the 33.52 level on April 26th, when the SPX was trading 3.6% above Friday’s close.
I also find it intriguing that the same option buyers that were buying calls at a relentless pace ahead of the recent equity downturn and volatility spike, are now buying VIX futures puts at the highest rate relative to calls since late 2020 -- which preceded a significant decline in the VIX.
The most recent option activity on VIX futures options should be welcomed by bulls, at least over the short term as one would expect equities to rally. That is, if this group is correct once again about the direction of volatility in the near term.
With the above said, a risk for those short VIX futures and long stocks comes Monday and Tuesday, since a plethora of currently out-of-the put options on VIX futures get set to expire Wednesday morning. Those that sold those puts likely hedge by shorting VIX futures. But as Wednesday morning VIX expiration nears, an unwind of those hedges could put a floor on volatility in the very near term.
While VIX option activity is hinting at lower volatility and higher stock prices in the short-term – keeping in mind VIX expiration risks on Monday and Tuesday – the longer-term scenario is much more complicated for equity bulls. As I alluded to last week. Short interest on SPX components is coming off multi-year lows, and continued breakdowns in the technical backdrop could embolden the shorts. Recent data with respect to April mutual fund and exchange-traded fund (ETF) inflows and outflows suggests that market participants are losing patience with stocks for the first time in a while, as their investments are beginning to lose money with the SPX in year-over-year negative territory. This group may de-risk on rallies, flipping the “buy-the-dip” mindset that has been prevalent since Covid-19 induced selloff in early 2020.
“The SPX’s 24-month and 36-month moving averages have been pretty good indicators of what is to come, based on the behavior of the SPX around these trendlines.… The SPX is still 25% above its 36-month moving average, and 12% above its 24-month moving average, admittedly too much to ‘bear’ in a wait-and-see approach. So, if you are emphasizing the long side after the recent SPX breakout, what is your ‘uncle’ point for guiding you in asset-allocation decisions?...the SPX’s 4,375 level should be your ‘uncle’ point to take action to lighten up on bullish positions you may have initiated coincident with the SPX breakout two weeks ago…If you are a longer-term investor, a VIX decline to the 16.00-18.25 area might be considered a place to put on a hedge to a long position, if that makes you more comfortable in this environment.”
- Monday Morning Outlook, March 28, 2022
While the above risks of increased shorting and/or continued outflows from equity funds is real, the SPX is now trading around its 24-month moving average. Major buying opportunities have occurred here over the years, but you should emphasize monthly closes when using this (and other) monthly moving averages as a guide to identifying potential risk and reward.
As I cautioned in late March, if the SPX experiences a monthly close below its 24-month moving average, it has a tendency to experience additional selling, with the 36-month, or three-year, moving average marking some, but not all troughs (2011 and 2018 are the most recent examples).
I find it interesting that as the SPX flirts with its 24-month moving average, a trendline connecting multiple highs from 2015-2020 and the round 4,000-millennium level, I saw a flurry of bearish headlines on Bloomberg’s app on Tuesday evening. Headlines that caught my eye were as follows:
“Wall Street Is Trying Desperately to Catch Up With Stock Rout”
“Turn Off the Memes, This Party’s Over Like in 2000”
“Stocks Will Be in Bear Market Until a One-Day, 5%-6% Drop, Gartman Says”
“BlackRock’s $100 Million London Trader Turns Bearish Amid Record Losses"
“Small-Time Traders Finally Souring on a Market They Once Ruled”
My immediate thought after seeing these headlines and reading the articles was “be on the look-out for a significant rally in the short-term, and albeit a lower probability, perhaps a long-term advance.”
But even after Friday’s rally, there is work to be done in terms of a resistance level lying immediately overhead that short-term market participants should be cognizant of in the days ahead. And as I outlined last week, there is a big resistance zone between SPX 4,170 and 4,375 that the SPX would have to move back above before I would even consider that a longer-term bottom is potentially in place.
“If there was any good news, the extended trendline that connected lower highs in 2022 until the mid-March breakout came into play last week and supported the various closing lows. The bad news is that this trendline extends to lower levels with the simple passage of time, implying it is simply limiting downside, but at lower and lower levels.”
- Monday Morning Outlook, May 8, 2022
For short-term traders, you should be aware of the trendline that I discussed last week as potential resistance in the days ahead. Unfortunately for bulls, after the extended trendline connecting the January-February lower highs acted as support in the prior week, it was unable to do so in last week’s trading.
In fact, after the SPX violently moved below this trendline in last Monday’s trading, it marked the SPX’s intraday highs during the rest of the week, including Friday. This trendline begins the week at 4,025 and ends the week at 3,991.
A quick pop early in the week above this trendline would give the scenario I laid out last week better odds of playing out. That is, if the SPDR S&P 500 ETF Trust (SPY -- 401.72) remains above the 400-strike as Friday expiration nears, there is the possibility of short covering related to expiring 400-strike put options that, per exchange data, had a buy (to open) bias. This implies the floor hedges the trade by shorting SPX futures. The downside of this is that there could be volatility around this strike if the SPY breaks back below it, as this would force the floor to short more and more futures. Heavy put open interest at the 380 and 390 strikes reside below, but both strikes had a sell (to open) bias, implying less potential expiration-related volatility around these levels.
If the trendline discussed above continues to act as resistance in the near term, the risk is a move down to a support area between 3,812 (20% below last year’s close) and 3,840 (20% below this year’s closing high), as marked with the green horizontal lines the graph below.
Todd Salamone is Schaeffer's Senior V.P. of Research
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