With the threat of an immediate hike in the federal funds rate off the table equities extended the advance started Monday as the bottom fell out of the US Dollar Index.
Last week started with the S&P 500 Index resting right on multiple supports ready to go either way, it only needed a little help from the overbought US Dollar Index and that’s just what happened as the dollar began selling off in Asia before the US markets opened. However, contrary to expectations interest rates and implied volatility declined suggesting the Fed would retain “patient” or some other dovish language in the Wednesday comments no doubt prompting some to wonder when the Fed cliffhanger drama will end. The majority opinion by far was for the removal of “patient” and they were right but the Fed replaced it with the need to be “reasonably confident” that inflation will move back towards the 2.0% objective before hiking rates, so the Fed simply moved the goalposts. The Fed cliffhanger continues.
With the threat of an immediate hike in the federal funds rate off the table equities extended the advance started Monday as the bottom fell out of the US Dollar Index. Let’s begin with a market review:
Market Review
S&P 500 Index (SPX) 2108.10 up 54.70 or 2.66% for the week and well off the upward sloping trendline from the from the October 15 it now challenges the February 25 high at 2119.59. Now negatively correlated with US dollar any further dollar decline will add support to the advance. However, since some selling is likely as it approaches the previous high, perhaps a hedge like the one suggested below could be worthwhile.
CBOE Volatility Index? (VIX) 13.02 down 2.98 for the week as approaches the 12.50 support level and the low of 11.53 made December 5, 2014.
The table below shows the VIX cash compared to the next two futures contracts as well as our calculation of Larry McMillan?s day-weighted average between the first and second months.
The day weighting applies 85% to April and 15% to May for a 25.94% premium shown above. Our alternative volume-weighted average between April and May, regularly found in the Options Data Analysis section on our homepage, is slightly higher at 28.31%, at the highest weekly premium in the last year. Premiums for a normal term structure are 10% to 20%; while premiums above 20% are unsustainable suggesting a lack of enthusiasm for VIX hedging often occurring around market highs suggesting overbought conditions associated with pullbacks. Alternatively, premiums less than 10% suggest caution and negative premiums indicate an oversold condition. Last week the premiums began at 7.80%, were 20.19% Thursday, ending the week at 28.31%.
In the one-year chart below, we marked where the week ending premiums were above 20% in support of our previously surmised guidelines above.
The data corresponding to points 1-7 above:
