Today, I just want to ?banter? a bit about the market.? In late January / early February, the market sold off around 6%.? Yet coming into today, the market was back knocking on all-time highs.? (In fact, as of this writing, we have exceeded the old highs.)? But, there are a few things different this time around!??
First, last time we were at these lofty heights in the SPX, the VIX was 17% lower than it was coming into today.? The RVX (volatility on the Russell 2000) was 19% lower.? So, the market has hung onto some of its volatility.? Is this a sign that the market sees more downside coming?? Possibly.? Let?s look at a couple of interesting “occurrences” in the market.??
First, let?s look at the historical volatility picture.? Though not too many traders were surprised by the velocity (and ferocity) of the down move, the same cannot be said about the upside move.? In fact, this upside move was almost as fast as the downside move and caught many by surprise.? And, it has carried beyond the 6% move of the drop.? This has led to the 20 day historical volatility maintaining its edge over the implied volatility for 12 straight trading days.? That occurrence takes place far less than 10% of the days.? This may have something to do with the extra VIX we have hanging around, more than any downside fear.? And, since the 10 day and 5 day HV?s are falling (although maybe not as much after today?s move), we may see a ?more normal? VIX soon.
But, what bothers me more is the shape of the VIX contango.? In a low IV, upward trending market, we generally see the first and second month VIX future spread trading for around 90 cents to a dollar (second month over front month).? It can certainly be much wider, but will generally revert to about that level near expiration of the front month VIX future.? And, when the market falls hard, that contango can turn to backwardation and the front month VIX future might trade for more than the second month future, as it did in early February. ?But, currently, as the market rallied, the contango has not steepened nearly as quickly as I would have anticipated.? In mid-January, the Jan/Feb spread was trading for $1.05 (Feb higher).? Yet, coming into today, the Feb/March spread was trading for around 30 cents.? This is quite low and makes me think the VIX is anticipating higher downside risk than last time we were at these levels.
Though I wrote this yesterday for a morning BNN show, I am updating it this afternoon and have the advantage of a little hindsight.? With the S&P?s up around $19.00, the VIX has fallen around 4% and the contango has steepened by 20 cents.? All ?normal occurrences in a rising market.
One last point though, lest I leave you thinking ?all is well?.? The S&P one month skew steepened considerably last week from its 31st to its 70th percentile.? The VIX skew flattened to a one year low due to call demand. ?(Info courtesy of Credit Suisse) So, there is still much fear / hedging going on.? Does this mean tough roads are coming?? No clue.? But, from my experience, when the ?big boys? are loaded up on protection, down moves tend to be less ferocious and more orderly if they occur, as the big guys are not dumping stocks or buying puts.? They are already ?insured?.