While Newton originally expressed it somewhat differently in 1687, the popular interpretation is that “An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.”
As it relates to the current equity market, our job is to anticipate what potential unbalancing forces could change the direction. Some analysts say a correction is due just because the S&P 500 Index (SPX) has advanced above the previous resistance now closing above 1500. While a correction to test the previous 1474.51 high is highly likely the timing and extent of the correction is unknown and will depend upon some unbalancing force, perhaps the Friday employment report.
Strategy
Last week we reported the professional hedging community was growing more cautious based upon a slight increase in the VIX futures premium. This week we see the opposite as the day weighted VIX futures premium between the first and second months declined from 19.54% to 12.54% while the volume weighted premium declined from 22.51% to 12.86%.
The VIX put-call ratio increased from .38 to .46 and the SPX equity only put-call ratio increased from was .54 to .64 making the spread between the SPX equity only put-call ratio and the VIX put-call ratio .18 compared to .16 the previous week for slight increase of .02. A wider spread is market bearish while a narrower spread is bullish since means the VIX put-call ratio relative to the SPX put-call ratio is lower. As the SPX put-call ratio increases it becomes more bearish while the VIX put-call ratio is more bearish (for the SPX) as the put-call ratio declines making the spread between them wider. However, comparing to the previous Friday, the VIX futures volume declined by 39,819 contracts and the open interest declined by 7,518 contracts. The combination of a lower VIX premium and declining open interest suggests moderately less professional hedging enthusiasm although one would expect to see more hedging in anticipation of a correction as the index continues advancing.
Since the iShares Dow Jones Transportation Average Index (IYT) appears to be the most overextended of the major indexes we are expecting the retest correction to begin here when it comes.
Volatility Kings
Although the options trading volume is lower than others, we are adding SunPower Corporation (SPWR) to our list since they are scheduled to report earnings on February 7 with a consensus estimate of .04 per share. At the last report the implied volatility reached 78 and we estimate it will reach 85 from 71.64 currently.