Saturday, August 26, 2017

Volatility Compression Likely

It appears that the huge amount of VIX call buying by dumb money at the recent market lows is more bearish on volatility than bullish on stock prices as over the past two weeks the SPX has risen 1% but the VIX has fallen 40%.  Last week, however, continued to show buying in the VXX as the dollar volume for Wed-Thur pullback of 15 SPX pts was almost as high as the 54 pt drop May 17-18.  Has Nostradamus predicted the end of the world?

I. Sentiment Indicators

The overall Indicator Scoreboard shows that bearish sentiment has risen to levels comparable to most of the market bottoms of the last two years, except Jan-Feb of 2015.

The Short Term Indicator (VXX $ volume and Smart Beta P/C) has seen bearish sentiment slightly exceed that of Jan 2015, but would also be consistent with at slightly lower low (SPX 2400) on a retest.

Both of the components of the Short Term Indicator show pretty much the same thing, so it is not just volatility hedging.

These sentiment measures seem to reflect traders, not longer term investors, however, as other measures as the SDS/SSO ETF ratio for the SPX or the QID/QLD ratio for the NDX do not show such extremes.

Moving on to other markets, bearish sentiment has continued to fall for bonds, indicating a rise in rates (TNX) is likely within the next few weeks.

Bearish sentiment has continued to rise for gold stocks (HUI), supporting moderately higher prices.

II. Options Open Interest

Overall, SPY open interest shows strong support at 240 with a likely trading range thru Sept 15 between 243 and 248.  Starting with Wed the 30th, 245 offer some resistance, but a move to 246 seems likely.

For Fri Sept 1, the range 245-6 offers less resistance, but delta hedging could go either way to 243 or 248 with 241 an outside possibility.

For Fri Sept 8, we have a similar setup to the Aug expiration where 245-7 is hedged and delta hedging could push higher or lower.  It is possible that with Congress back from recess that some news related to the debt ceiling could be a catalyst for a move either way.

For Sept 15 expiration, a pullback to the 243-4 area seems likely if prices remain higher.

Looking to an extended range for Oct 20, the period following the Sept 15 expiration is the most bullish with 247 most likely and a move over 250 with delta hedging is possible.  This seems to reflect the possibility of positive action on the tax cut proposal.

Conclusions.  First, I want to point out that I was mistaken last week in the bearish outlook from the Oct VIX option open interest.  I interpreted it similar to the SPY, but in retrospect low VIX calls are neutral as shown by the VIX call indicator.  So looking at overall sentiment, we have very high bearishness for the shorter term indicators for stocks, moderately high bearishness for gold stocks, and low bearishness for bonds.  All indicators point to some resolution of the Trump tax plan and/or debt ceiling that will be positive for growth and inflation prospects.  The most likely time period indicated by the options OI is mid Sept to mid Oct with the SPX possibly rising over 2500 by Oct 20.

Weekly Trade Alert.  The SPX missed my target range (2405-15) by two pts.  With two open gaps at 2428 and 2468 it's hard to tell which will be filled first.  I view a drop to SPX 2420-30 as a BUY and a rise to 2475-85 as a SELL short term.  Updates @mrktsignals.

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