S&P strength and VIX weakness spells risk

The risk that the S&P might find some spirited selling, even before year-end, is as great as it has been in weeks or maybe month — if only someone was trading.  Since the Dec. 16 test of the 50-day moving average, ESH4 made seven new highs without a three session pause, the most recent on Friday. Seven new session highs mark an important starting point for overbought conditions.  Friday’s session also created a ‘doji’ pattern indicating indecision, which is not consistent what one should expect from a strong bullish camp following continued record highs.                                                

To the above, I recommend taking note of the price action in the VIX over the last days.  On Thursday, this market reflection of estimated future volatility fell to its lowest level since mid-March before rebounding to settle only marginally lower on the day.  VIX price action on Friday did not validate any bearish implications from Thursday’s plunge, but rather recovered smartly nearly completing a more dramatic bullish reversal.                                                                            

Together, the indecisiveness of daily price action in the S&P along with the general complacency shown in the low VIX condition for adverse reaction to even mildly bearish news.  How is to know if the repercussions from Russian bombings or unrest in Turkey are to stir enough disquiet to compel otherwise complacent equity longs to take profit, thus prompting a more excited slide.

Managers have been forced over recent weeks to join in, buying and pushing prices higher to repair books that would otherwise have shown less than attractive year-ending positions in this banner year.  Support from this buying is likely exhausted and patient longs may not wait much longer to take profits.

I have initiated sales in the index and purchased 18-day 1800 puts to take advantage of a potential fall.  

About the Author

Martin McGuire, managing director at TJM Institutional Services

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