VIX Wake-Up Call

This article was originally published on Nadex.com.

In the end, everything seemed to catch up with the stock market on Friday, and that includes the VIX. The equity markets were extremely overbought, and the sell-off was one of the most vicious in years - and it probably isn't over. The VIX jumped to 17.31 and settled at its highest level since the roiled markets of the November 2016 U.S. presidential election.

Friday’s big equity drop comes after a big upswing that started last month. In January, the VIX was rising even as the S&P 500 climbed more than 7%, the greatest percentage increase in 14 years for that index.

One of the things that helped cause the big jump in volatility was the yield on the 10-year treasury note.  The yield hit its highest level since 2014, and at the same time, inflation has started to creep up.

The VIX has been trading at historical lows for an extended period of time until recently. According to Pravit Chintawongvanich, Head of Derivatives Strategy at Macro Risk Advisors, who originally gave a certain market participant the name the ‘VIX Elephant,’ that trader may have traded 2 million contracts Friday - closing out positions that expire in February and rolling the trade over to same-strike options that mature in March.  

Another trader who is dubbed ‘50 Cents’ for his trading style of buying near-dated VIX options priced at around 50 cents also appeared, trading a block of 50,000 VIX March 28 calls for 48 cents each at 10:53 a.m. New York time.

In both instances, these traders would have been holding on to trades for several months, betting on the volatility index to increase in price, and now they are finally starting to see trades go their way. Many traders believe the VIX will go above 20 - and after the January spike in price, that is only a few dollars away. The question is, how much pain will investors have to take until the markets start to firm up?   

Dow’s ‘666’ Point Fall

Thursday night, when the S&P 500 futures abruptly sold off 12 handles, the situation did not look good; but even then, I did not anticipate the Dow falling 666 points. It was a scary day, but it was also long overdue. As they say, the markets always go down faster than they go up; and Friday’s sell-off was all about the small failed rallies and the speed of the decline.

But it wasn't just the stock market that fell. The sell-off spread to commodities also.  Gold futures fell 0.8% to $1333.70 an ounce and crude oil dropped 0.5% to $65.45 a barrel. But what really weighed on the equity futures was the benchmark 10-year Treasury note's yield rising to 2.852%, its highest level since January 2014.  The S&P 500 closed the week down 3.9%, and the Stoxx 600 had its worst week in nearly two years. The S&P 500 has now sold off 142.50 handles in a week’s time.

Our view is that there should be a decent bounce; but the big question is, will the rallies hold? It's our guess that there is still some pain to be applied to the downside, but that doesn't mean the ESH18 can’t bounce to 2760 or higher first. The dip buyers will not just roll over and die.  However, if the yield on the 10-year note trades to 2.9%, there could be another big slide. A key level to watch is Dow 25,000, about 400 lower from where it closed on Friday.

Another wild card will be the Pyeong Chang 2018 Olympic Winter Games, which begin on February 25th. What better time could there be for North Korea to do something provocative? If the S&P does fail, the next levels would be 2730, 2700 and then 2675-80.

 

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