A climax in options trader pessimism could still serve as a coincidental tailwind
““If you are aggressive and anticipate the SPX breaking out above resistance, the one indicator that is giving you permission to do so is the CBOE Market Volatility (VIX – 15.03). In early April, the VIX hinted at higher volatility ahead when it closed above 15.40, or half the 2023 high. It then closed above 18.68 at the start of April expiration week, further hinting at weakness. Since peaking just below the October high point on April 19, it has come down sharply.”
-Monday Morning Outlook, April 29, 2024
In late April, the Cboe Market Volatility Index (VIX–12.17) hinted at lower volatility and higher stock prices with its move back below the key 15.40 level (one-half its 2023’s high). It proved timely, with the SPX powering higher like a rocket starting on the first trading day of this month.
At the time, it was about the only sentiment indicator that we track hinting at higher stocks prices, as negative sentiment was still building among equity option buyers and active investment managers, a potential coincidental headwind.
Since the first day of the month, the VIX has tracked lower, moving below the 2023 close at 12.45. And on Friday, the VIX closed at its lowest level since November 2019 and just above the intraday lows of December 2023. The Friday close is just above 11.54, which is one-half its October 2023 peak, and might help explain why a trough was made in this area in December 2023.
As such, a risk to bulls is the VIX lifting sharply off these prior lows amid lower stock prices. A move above 12.45 might be the first hint of trouble. At the same time, if the VIX moves below recent lows, a move to 10.68, or one-half the April intraday high, is not out of the question. A decline to this level would likely occur in the context of a continuation move after the S&P 500 Index’s (SPX—5,303.27) breakout above all-time highs last week.
“…after three weeks of rally mode, the SPX is again approaching potential resistance from the index’s all-time closing high of 5,254. Note that this closing high in late March occurred just above 5,235, or exactly 10% above the 2023 close. If looking for an entry point on the SPX, await a breakout and close above the all-time closing high with a stop just below it…one by one sentiment indicators are turning more in the bulls’ favor.”
-Monday Morning Outlook, May 13, 2024
The one technical indicator that gave bulls hope when the VIX broke below 15.40 in late April was the SPX’s 80-day moving average, which was for the most part providing support. While not a popular moving average, I have noted its importance whenever it comes into play. Just as it had importance in late 2023, it marked the approximate low earlier this month. Those that are aggressive are being rewarded for entering at the 80-day moving average as the VIX declined below 15.40. A move below the upward sloping 30-day moving average, currently at 5,102, would be an exit point to consider.
For others taking a wait-and-see approach, the breakout above the March all-time high provided permission to enter, especially with sentiment indicators moving more favorably in that direction, indicating the pessimism build-up had climaxed. But by being less aggressive, you may want to keep your stop-loss tighter. A move below the 5,200-5,220 area would present risk for short-term traders that entered on the move to all-time highs. The 5,220 level is where the SPX broke below its January through March bull channel, and thus the area between the 5,200- century mark and 5,220 should be supportive on pullbacks.
“One sentiment indicator that moved in options bulls’ favor last week was the 10-day, buy-to-open put/call volume ratio on SPX components. It is now showing hints of rolling over from a relatively high level. This type of behavior typically comes up as the market begins a basing period around the eventual lows, withs some rollovers in the ratio coinciding with bottoms.”
-Monday Morning Outlook, May 6, 2024
Per the chart immediately below that displays the 10-day buy (to open) put/call volume ratio on SPX components, it appears that the climax in pessimism that we discussed two weeks ago is firmly entrenched among short-term market participants. This presents a potential coincidental tailwind, as optimism in this group is in the early to middle stages of gathering momentum.
With the SPX in new all-time high territory, the next potential profit-taking level could be around the 5,500 half-millennium mark, which is about 20% above the December breakout above the July 2023 high at 4,600.
Todd Salamone is the Senior V.P. of Research at Schaeffer’s Investment Research.
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