MORRISTOWN, N.J. (MarketWatch) — Heading into Tuesday, I didn’t think the market could act any worse, but it did. It’s almost impossible to fathom that the market was rising with improving technicals eight trading sessions ago.
With the current uncertainty in the stock market, the $VIX index has once again received a lot of financial media coverage. Last week we recommended the purchase of $VIX calls as a hedge for your portfolio. We received numerous comments from people who took our advice but didn't seem to understand how $VIX options price.
Suddenly, the stock market started to develop "religion" about the U.S. debt situation, and sold off sharply this week.
In one sense, this is like any other "event" -- an FDA hearing or a potentially volatile earnings report: the underlying has trouble moving decisively in either direction until the event has passed.
There has been something of a “buzz” in volatility forums and in some media articles about a backspread strategy that is designed to take the loss out of using $VIX options for protection or speculation. As you know, we are running a “perpetual call buy” strategy for long $VIX calls (Position S610). Also, this week we recommended the purchase of $VIX calls as protection for stock portfolios, for those who were worried about what might happen in the event of a downgrade of U.S. debt or a failure to raise the debt ceiling.
Are you worried that the wrangling over the debt ceiling might become a crisis for the stock market? A number of analysts are predicting dire results if the ceiling is not passed by the August 2nd deadline. In fact, some say that even now it's too late to keep the U.S. credit rating at AAA. I think the stock market as a whole is smart enough to discount these possibilities, and therefore such worries are probably overblown since the market is rallying, not plunging.
Thursday's breakout upside move in the stock market has solidified the indicators together into a bullish posture. The chart of $SPX held onto a bullish picture even though the selling in the past two weeks was heavy at times. The 20-day moving average has been rising all along, and the index never closed meaningfully below that average
Equity-only put-call ratios have remained bullish, as they have continued to decline from their high peaks of a month ago.
The market had a powerful showing Tuesday with the Standard & Poor’s 500 Index rallying 1.6% for the day. Market indicators suggest a potential 100-point rise in the index over the next few months.
July $VIX settlement took place this morning. The official settlement price was 19.10, just slightly below last night's $VIX close of 19.21. All outstanding June futures and options contracts will settle at that price. For example, if you own a July 20 put and didn't sell it prior to today, it would settle for 0.90 ($90 per contract), since it is 90 cents in the money (20 minus 19.10).
The market action this week has been quite bearish and, frankly, quite out of character in terms of the indicators, but it may also be a rather severe reaction to the overbought conditions that had built up.
The S&P 500 Index ($SPX) had strong upside momentum a week ago, but ran into resistance very near the April highs.
Equity-only put-call ratios are bullish and have remained bullish even during this week's decline.
The stock market continued its bullish explosion this week. $SPX broke through its previous down trend line last Friday, and has now overcome the late-May high. All that remains is a test of the post-2009 highs at 1370.
Equity-only put-call ratios turned bullish when they peaked and began to fall. These are intermediate-term buy signals.
Market breadth has been very strong during the rally. Breadth indicators remain on buy signals, but are now very overbought.