Randy Frederick, managing director of active trading and derivatives at Charles Schwab, says that recent moves by European Central Bank President Mario Draghi and Federal Reserve Chairman Ben Bernanke have "taken the majority of downside risk out of the market."
It’s been a busy two weeks in the financial world. First came Draghi’s introduction of the Outright Monetary Transactions program, allowing for unlimited purchases of sterilized government debt; then the Federal Reserve announced an open-ended third round of quantitative easing, which entails purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Fed will also continue with “Operation Twist” (extending the average duration of its holdings) and pushed its commitment to keep the Fed Funds rates at “exceptionally low levels” out until mid-2015.
Frederick says the moves by Draghi and Bernanke, "[Explicitly say] they’ll do whatever it takes to support their respective economies."
Last week, options industry volume was nearly double the low levels traders saw during most of August, but still falls far short of last August’s spike, which resulted from fears over a potential collapse of the euro and fallout from the debt ceiling debate. “It appears that fear is indeed a stronger emotion than greed,” Frederick says.
For the seventh time in the past nine years, September looks to be a positive month, despite its bearish reputation, Frederick says. He predicts that the market is due for consolidation or a small pullback, as the SPX remains above his near-term resistance levels of 1435 and 1447, but says that "it's difficult to imagine a really sizeable pullback outside of a major unexpected news event" such as a terrorist attack or an Israeli strike against Iran. He also anticipates that traders will soon “begin to focus on the psychologically significant level of 1500.”
Frederick adds that the recent strength of the market has caused the CBOE Volatility Index (VIX) to decline. “While a low VIX is not necessarily indicative of an inevitable spike,” he notes, “it does tend to magnify the intensity of any spikes that might occur.” He estimates that even small news items could result in a spike of four or five points, but anticipates that the VIX would quickly stabilize. “[The VIX] tends to react to the market far more often than it predicts it," he says.