Thursday saw a short-term volatility spike across the board as stocks were hit in early trading. But both reversed course, leaving a reversal candlestick on the VIX Volatility Index. Let’s explore some charts to get a fuller picture of the volatility market.
The last data point in Chart 1 is as of yesterday and uses intra-day highs rather than the close. The VIX-to-VXV ratio is calculated by using 22.89 for VIX and 23.53 for VXV. They respectively closed the session at 19.37 and 21.16. Using the closing price would result in a ratio of 0.915, rather than the 0.973 used in the chart.
Market participants have been actively buying short-term protection. It is volatility’s recent behavior that leads to unwinding of the oversold conditions the ratio was in before it started rising last week with a surge this week. The ratio remained suppressed for 12 long weeks.
Not that the green line in Chart 1 cannot continue pushing higher. It has in the past, as is evident. But with each push higher, reversal odds grow.
The VXST (nine days)-VIX (30 days)-VXV (90 days)-VXMT (six months) volatility curve shows the near panic yesterday (and volatility spike) in buying short-term protection. Chart 2 below uses yesterday’s intra-day highs. VXST shot up to 26.94, north of three points higher than VXMT. In less than three weeks, the volatility curve shifted from steep contango (grey line) to backwardation (blue line).
The recent volatility spike has come in the midst of rather gentle selling in the S&P 500 index. From June 8th through yesterday’s intra-day low, the index dropped 3.3 percent (see chart 3). That’s it! In the meantime, the VIX spiked 10 points in eight sessions, and went from the lower Bollinger Band to the upper band in no time.
VIX’s candle yesterday has an ominous look to it (see chart 4). It looks like a volatility spike and reversal, leaving a long wick. Several times in the past spot VIX has surged, only to reverse hard and then sell off. Daily conditions are grossly overbought. And in the event of a ‘no’ vote on Brexit on the 23rd, risk-off likely reverses fast near-term.
In fact, this scenario is precisely what stocks (and the S&P 500) seem to be anticipating. Yes, the large cap stock market index has lost shorter-term moving averages, and lost the 50-day as well before recapturing it yesterday. But, it has not fallen apart given the steep volatility spike in June.
This is particularly so as the S&P 500 has failed to break out of the trend line drawn from the all-time high of May 2015 (chart 3). Normally, a failure of this nature results in a sharp sell-off… has not happened yet. Yesterday, it reversed with a hammer, although volume could have been better.
Near-term, although the two have diverged, pretty soon either the S&P 500 rallies, putting downward pressure on spot VIX Volatility Index, or the latter remains firm and the S&P 500 rolls over. On a weekly chart, there is plenty of room for the latter to go down.
That said, stock market bulls should take heart from yesterday’s action in the VIX.
In past times like these, a volatility spike and reversal on the VIX has proven to be a reliable signal (arrows in Chart 4). There was one yesterday.
Thanks for reading!
Twitter: @hedgopia
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Author may hold a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
