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Last year (2018) was a very interesting year in a number of respects. One of those was the behavior of volatility and especially the behavior of volatility derivatives. Since one cannot trade $VIX but must instead trade one of the listed products – $VIX futures, Volatility ETN’s or ETF’s, or options on those instruments – there are some nuances involved. Since all of those instruments are based on $VIX futures1 , that is where we’ll concentrate this discussion.
We often talk about how the stock market usually trends in the opposite direction from volatility ($VIX). But how do we really measure the trend of $VIX? Often, we use the 20-day moving average, but that is a very short-term moving average that changes trend easily. In a longer-term bull or bear market, we would not want to swing in and out of a “core” position when we are trying to stick with the trend.
If you enjoy seasonal trading patterns, they abound from the end of October (the “October Seasonal,” which was strong this year), through the beginning of the new year (the “Santa Claus” rally). Over the years, we have combined three different late-year seasonal patterns into one trade.
The three patterns are as follows:
Several times, we have mentioned the fact that in a bear market, there is usually selling in October, followed by a strong October Seasonal rally, and then a failure of that rally in early November. If it is truly a bear market, new lows are made in November or early December.
On Wednesday, $SPX made a huge move to the upside, rising 58.44 points in a massive display of buy programs that lasted right into the closing bell. Is this the way the market behaves when it’s ready to launch higher, or it is a sign of merely oversold buying which leads to lower prices shortly thereafter? That was the 9 th largest point move in history. Of the other nine in the “top ten” of such moves, every single one retraced that gain – gave it all back – in a fairly short period of time. I was a bit amazed to see that, but if you think about it, the only time the market can rise like that is in response to a very oversold condition – which means the market was already in a downtrend to begin with. So, these large moves have proven to be only temporarily bullish.
Conventional wisdom holds that October is a bear killer. That is, the market starts to head south in September, accelerates in early October, and then bottoms some time in October. From there it rallies. So the decline – while sometimes very steep in early October – is terminated in October. Hence the term “bear killer.”
Last week, we wrote extensively about the similarities between the current market and the market of the summer of 2000. In 2000, $SPX rallied back to its old highs, forming a double top right around Labor Day. From there, the market declined 50% into the summer of 2002.
Last week we published an article showing the different reactions of $VIX to the initial 6% drop in the stock market in early February, as compared to the 6% drop in the stock market in March. In February, $VIX exploded from essentially 15 to 50. In March, a similarly-sized move in the stock market only produced a rise in $VIX from about 15 to 25. That’s a big difference. For reference, those reactions are shown in Figures 5 and 6 – reprinted from the last issue.
As trading opened on Monday, February 5th, 2018, stocks had already been falling for a few days. Then on that day there was a major decline – the largest drop in point terms in history. The Dow was down 1,175 points. The S&P 500 Index ($SPX) was down 113 points. All other major stock indices suffered similar fates. Those net changes were effective as of the 4 p.m. (Eastern time) close of the NYSE.