The volatility beast has finally awoken. His revival was as sudden as it was strong. Option sellers, long since enriched during his slumber, are finally receiving their comeuppance. This was one of the nastiest weeks in months for traders wielding short volatility strategies with a bullish tilt (I’m looking at you naked puts and bull puts).
I am, of course, talking about Thursday’s super spike in the VIX which launched the popular implied volatility measure 44%. Curious minds want to know if volatility’s emergence is here to stay or if the beast simply needed a midnight snack before further slumber. I’m afraid it’s the former, but am hoping for the latter.
I’ve included a rare picture of the volatility monster’s revival for your viewing pleasure. And no, he’s not a llama.
I don’t think the timing of volatility’s return is coincidental either. August and September are known for their correction delivering ways. Seasonally speaking, this is when bears roam. Since these VIX spikes don’t happen all that often, let’s take some time to highlight the implications.
The VIX ramp is caused by increasing demand for options. Pure and simple. That means the denizens of the Street are paying up for protection. And it shouldn’t be surprising. It always happen when stocks slip on a banana peel. The elevated demand has inflated option premiums. So now they cost more. That means you have to pay up if you’re going to buy them, but you get paid more if you’re selling them. To capitalize on the pumped up premiums consider strategies like naked puts, bull puts, and iron condors.
Here’s another takeaway. Higher VIX levels imply the market is expected to be more volatile moving forward. For example when the VIX was near its record low last month of 8.84 it was pricing in daily moves in the S&P 500 of 0.55%. With Thursday’s spike to 16, the expected daily move jumped to 1%. If you don’t think 1% daily moves in the market are going to be the new normal, then you’re of the opinion that a 16 VIX is too high.
Pick Your Path
In light of volatility’s return, we need to take a fresh look at the overall market. I’ll start with the S&P 500. The oversold bounce that commenced on Friday can follow one of two paths. Either we experience a sharp “V”-shaped reversal like all the other selloffs over the past year, or this bounce fails resulting in a lower pivot high and subsequent rollover.
The previous four rebounds are shown below. You can see why the buy-the-dip crowd has been emboldened this year.
I suspect the bounce will fail and am thus positioning myself to be a seller of the next rally. The forecast is illustrated with the black dotted arrows. But the S&P 500 isn’t my favorite index to fade because it’s not the weakest. For that, we turn to the Russell 2000 which was handily beaten this week.
Relative weakness has plagued small-caps all year long. In fact, the ratio of the Russell to the S&P 500 (RUT/SPX) just fell to a new 10-month low. Small-caps weak sauce behavior was on full display Friday. While tech stocks rallied 1%, IWM circled unchanged all day long.
Last week’s plunge ushered IWM (the Russell 2000 ETF) below key support at $139. And now it’s testing the 200-day moving average. The odds favor some type of oversold bounce next week, but with so much potential resistance looming overhead, it’s a rally that’s likely doomed. The heavy distribution in volume doesn’t help matters much either.
To round out my commentary, let’s take a look at an area that looks attractive for a buy the dip play – emerging markets. Unlike small-caps, emerging markets have been exhibiting relative strength. Their gains have bested those of the S&P 500 all year long. Plus, the overall uptrend for the space remains healthy. Last week’s profit-taking took EEM below the 20-day moving average, but not below the 50-day.
Additionally, we saw a nice jump in implied volatility that has increased option premiums.
As mentioned, the long-awaited and much-anticipated VIX spike has arrived. If you timed the pop with long volatility trades, I salute you. Your chance at selling options for respectable premiums has officially arrived. Further selling next week will lift the VIX even further, but I suspect a top is nigh. Whether its at 18 or 20 or ?? remains to be seen. Just remember, VIX spikes were made to be sold. That can be accomplished via short premium plays in SPY, IWM, and other Index ETFs, or via bear plays on VXX.
On the sector front implied volatility remains highest (yet again) in tech and retail (see SMH, QQQ, XRT). But what have we here? Financials are getting in on the high IV action. Welcome, XLF!
End of week readings: VIX 15.51%, SPY 5-day Historical Vol 10.59% (Movement! We have Movement!), SPY 20-day Historical Vol 5.91%.
- AA, BA, EA, AMZN, MSFT, TWLO, EEM, FEZ, FSLR, GPRO, TSLA
- CSX, MMM, IWM
Tyler Craig is a professional in the world of technical analysis. As a member of the Chartered Market Technician Association and a Chartered Market Technician (CMT), he brings an insightful perspective to his commentary. Over the past decade, he has educated thousands of traders through his work with Elite Legacy Education. He is the architect of Tackle’s own Technical Analysis 101, Options 101, and Condors for Cash Flow video series as well as the forthcoming Ultimate Bear Market Survival Guide. For a taste of his witty banter and rare ability to demystify complex financial concepts check out his current home, Tales of a Technician.
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.