Yesterday I posted a chart of the NYSE advance/decline ratio on which I highlighted that the past two weeks were more reminiscent of patterns we see during lows and not something we observe during advances. FWIW – right at the top I am also seeing our coveted Gothic Church Tower fractal, have a look:
Well, one of our fellow steel rats decided to chime in and shared some rather interesting statistics:
I see other things, that normally happen at lows. For example, ES open interest is about 2.9 mil cars. Last time it was that high in end of May – beginning of June. A time before that was in end of November 2011. Also significant low. Sept – Oct of last year was as high as 3.1 mil cars. I started to keep these records around that time, because I noticed that open interest increases when market falls. Its not a fact, just my observation. I could not find historical data, so can’t check if its reliable at all. Also, I understand that open interest may naturally increase towards expiration, because more and more people getting stuck, but during Jan – Feb this year it stayed around 2.5-2.7 mil. And right now we are nowhere close to expiration anyway.
Now let’s look at another chart that is looking rather peculiar, given that we are currently trading 14 handles below this year’s highs:
Just eight sessions ago the VIX was frolicking below the 14 mark, dropping as low as 13.3. Today we almost touched 17 and that’s an increase of 22%. And this, my dear steel rats, is exactly what I was referring to a few weeks ago when I suggested OTM put lottery tickets. While prices on the underlying have barely moved premiums on SPY or SPX puts for instance have risen simply due to a 22% increase in vega. Even calls bought near the top should have remained near break even, despite the 14 handle drop.
Case in point – SPY ATM calls bought on the 17th – after 12 days of theta burn and a 14 handle drop have only lost 60 bucks. Know your greeks folks!
But wait there’s more – make sure your tinfoil hat is in place and you have tightened those chin straps. Here’s another chart I posted two days after we painted those lows on Mr. VIX. Remember those peculiar spikes we saw on the SPX:VIX ratio?
Someone got to buy premium at bargin basement prices and whoever did is now smiling all the way to the bank. Despite the fact that the SPX is trading only 14 handles below its highs. Nevertheless all characteristics of the tape in the past week point toward an ongoing correction. But it may just be a sideways one. Which means that give it a few more days of this Chinese water torture and the Mole may just get excited about the long side again. For now I remain guarded – but the odds of upside continuation will increase vastly once that NLBL expires. The bears had plenty of chances here to take things down by a notch or two but thus far it’s not happening.
But the running theme of today’s post is that we seemingly have reached an inflection point across the board. I am seeing an almost identical configuration fall into place across both currencies and commodities. So let’s take a look, shall we?
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It’s Friday evening and I decided to go all Dirty Harry on your asses. The center of my post are two simple charts that I saved for the weekend – just in case you were feeling that sudden urge to make any big bets up here.
Exhibit A – our beloved volume profile chart – the gift that keeps on giving. I post this one regularly and I’m sure you’re all familiar with it. What’s salient about it right now is the fact we pushed right up to our current volume abyss, which thus far has been proven to be impenetrable.
Since Tuesday no real attempt to breach it has been made – every time we get close we seem to be running out of fuel. Which confirms that despite all the alleged risk appetite out there nobody is eager to take this thing much higher here – at least not right now. My take is that some after-hours or weekend event would be needed – some f… you candle that gaps the majority of traders and bridges the gaping volume hole looming above. Always a possibility but then there’s this:
Exhibit B is a long term view of the VIX. Since the 2007/2008 debacle we have a well established support line which over the years has been slowly dropping from about 17 to into 15 right now. Depending on how you draw it you can add another handle and thus 14 is your uncle.
Now considering these two charts the big questions you need to ask yourself right now is this: Is it really wise to be delta positive right now and right here? Even if we spike higher next week on heaven knows what after hours news event – is being long here worth the downside risk? Granted currently there are no technical hurdles on the horizon that would preclude us from reaching VIX 14 or even 13. But you have to ask yourself: What are the odds? Do you feel lucky, punk? Well, do ya?
Actually – I do. With a VIX this low I am starting to think about some delta negative strategies. The only problem is that I wish I had more technical reasons to be short here – and that’s the one big fly in our ointment. So we have to make a choice – either give this one a miss or use a strategy that will not cost us much if we wind up being wrong. Which by the way could easily happen – I am not going to sugar coat this and I have made it pretty clear recently that we are in technical limbo here. Even our inside day setup from Wednesday has been shot to hell at this point.
Given this the one medium term strategy that makes sense is to dip into some cheap lottery tickets – a.k.a. far OTM puts either front month or the next. Since August only has 7 days left I would go with September puts. If we push higher from here then you will lose premium but at least you won’t be vega squeezed and that should contain the damage. But if we drop from here and premium shoots up then we’ll bank some mighty coin. So a few lottery tickets it is – at least for this market megalomaniac.
In order to pick those lottery tickets we need to consider what our prospective support zones are. That’s basic reversal play 101:
On the daily we have the 100-day SMA at 1355, the 25-day Bollinger at 1320 and the 100-day Bollinger at 1290.
On the weekly we have a NLSL at 1340 and on the monthly a NLSL at 1320. So it seems 1355 to 1340 is our first range and 1320 is a strong contender for a little wipeout target.
Based on that I picked two lottery tickets – the September 135P and 132P on the Spiders. As you can see the profit potential is rather nice but it’s a rapid increase in vega that would result in an explosion of our premium. As a matter of fact – we could stay right here where we are and an increase in vega would bank us some coin.
As I said above – technically there is not much on the horizon that suggests a reversal here. But with a VIX near a historical support line it does not make sense to be long here – simplemente no vale la pena. The play I suggest makes sense but it’s a long shot and I call them lottery tickets for a reason. So if you decide to grab some of them then I suggest you only use a tiny percentage of your portfolio. You don’t want to lose any sleep over taking on speculative positions – if you do reduce exposure until normal sleep pattern resumes.
Enjoy your weekend.
As I was perusing the comment thread this morning I saw a few musings on how to best get positioned near a potential market bottom. The option strategies that were suggested are definitely reasonable (i.e. regular credit spreads) but IMNSHO non-optimal during times of rapid volatility spikes.
In order to set the stage observe that IV as expressed by the VIX has jumped by 30% in the past month. Thus I decided to put a together a quick and dirty write up on an exotic beast called a ‘reverse calendar spread’ – a.k.a. ‘reverse diagonal spread’.
Let me however precede the following with a caveat – I am not suggesting that a market bottom is already in the works but I’m pretty comfortable in proposing that we will see one in the next five sessions.
We all know that high volatility associated rapid sell offs offers tremendous profit potential – in theory. The truth of the matter is that even seasoned traders are often only familiar with the most basic option strategies, which unfortunately do not apply well in an environment of high volatility. Obviously the most straight forward approach here would be to simply sell vega via shorting puts but unless you have suicidal tendencies I would not recommend that as an actual option (pun intended).
Bull and bear debit spreads are generally poorly priced when there is high implied volatility (IV). When a bottom is finally achieved, the ensuing collapse in premium due to volatility crush often strips away much of your profit potential. Many a traders have been punished this way and often they are not even aware of what happened and that vega is to blame. So even if you get the timing right and are able to get positioned you may easily see yourself being stripped of most of your ill gotten gains during a snapback move following a capitulation sell-off.
This is why I propose at a simple strategy that actually profits from imploding volatility irrespective of market direction (theoretically – more on that below) and requires little up-front capital if used with options on futures or ETFs. Even better, as long as IV drops or remains stable (e.g. after a big push outside the 2.0 BB) it has little or no downside risk, thus reducing the bottom-picking dilemma. The strategy also offers some very juicy upside profit potential if things start accelerating to the upside and vega is being crushed, thus causing an increase in pain that is often referred to as a short squeeze. The basic idea of this strategy is the inherent opportunity offered by a sharp drop in IV. By neutralizing delta and gamma and getting short volatility, or short vega, the strategy is a great tool in our arsenal for banking coin near market bottoms.
As most of you rats already know a high VIX means that options have become extremely expensive because of a surge in volatility, which massively affects option premiums – calls and puts alike. This presents a conundrum for option buyers – whether of puts or calls – because it leaves you long vega just when you should be short vega.
Thus the most straight forward solution is to sell options which leaves you short vega and thus able to profit from a volatility crush. However, especially during times of a potential medium to long term trend change (i.e. bull market rolling into a bear market) it is of course very much possible for IV to push even higher. And if you are being caught short vega under these condition then it can very quickly lead to significant losses.
The Solution: Reverse Calendar Spreads
Traditionally calendar spreads are considered neutral strategies, involving selling a near-term option and buying a longer-term option, usually at the same strike price. The idea is to have the market stay confined to a range so that the near-term option, which has a higher theta (the rate of time-value decay), will lose value more quickly than the long-term option.
Another way to use calendar spreads is to reverse them – thus buying the near-term and selling the long-term, which works best when volatility is very high. The reverse calendar spread is not neutral and can generate a profit if the underlying makes a huge move in either direction. The risk lies in the possibility of the underlying going nowhere, whereby the short-term option loses time value more quickly than the long-term option, which leads to a widening of the spread – exactly what is desired by the neutral calendar spreader. Having covered the concept of a normal and reverse calendar spread, let’s apply the latter to SPY call options.
Back To The Real World – SPY Example:
All the above may be confusing to you so I put together an example with regular SPY options on the trusty TOS option simulator – a fun diversion for lonely weekends, for example if the local nudie bar is closed for renovations. Heck, it beats reruns of Friends – at minimum it’ll teach you a lot about option greeks.
As we are optimists I’m showing you the winning side first. The ThinkOrSwim simulator does a great job of showing you that you are effectively neutral delta and gamma. We have SPY trading near 130 and are currently counting 63 days to the expiration of the July 130 call. The trade is constructed using simple SPY call options. I think initial margin requirement for the spread shown above is around $200.
So assuming SPY trading near 130 and expecting a bottom in place soon (which again may not be the case – this is just an example) we buy one July 130 call and simultaneously sell one September 130 call, which leaves a net credit of ~$217 before any commission or fees. This should best be done by an experienced broker who can place a limit order using a limit price on the spread or you can use the TOS platform which allows you to automate the process and ensures that you are not being partially filled. It is very important to understand that the goal for this spread is to close the position at maximum 30 days ahead of expiration of the near-term option (Oct expiry), a bit sooner is better.
As you can see in the above chart – as long as vega drops from here you really don’t care where prices are going as you should be able to bank some mighty coin. If you expect only a short term spike then you may have to play this one with weekly options with the sell side being three or four weeks away but that is really outside the scope of this little example.
But of course we all know that vega would explode even higher should prices continue to drop lower – in particular if we breach the proposed support clusters I have pointed out in the past few days. Which really renders your profit potential during a drop associated with dropping IV nothing but academic. In essence on the very first chart you can ignore the simulated profit curve below the 130 price point. Why? Because it is unreasonable to assume that vega will drop if we continue much lower from here – most likely it’ll jump higher. On the inverse anything above 130 on the loss simulation above can be ignored as well as we most likely won’t see IV run higher if prices are starting to snap back.
Obviously I have skipped much of the meat on how to calculate and structure each side of an reverse calendar spread. But that really wasn’t my focus and there are plenty of great tutorials out there if you want to get into the nitty gritty. What’s important to understand is that a RCS can effectively be used during supposed market bottoms and may be preferable to other credit spreads.
Here’s an example of a regular vertical credit spread and with volatility falling in 5% increments. As you can see those profit curves flatten out rather quickly.
Getting the timing right of course is an art in itself but I thought that a 30 day window may be a good compromise. If you want to put together something more short term then you may look into playing the weeklies. But that’s a completely different story as they move a bit more like futures and react differently to theta burn.
So I (volar) do not have much to say for a market outlook- though the VIX 8 day stat worked out well (with hindsight and inductive reasoning bias).
Banking coin is never easy- but avoiding stupid decisions really makes the difference. Convict keeps it simple- and frankly that is why he is solvent. Solvent traders have a better probability to make coin than the insolvent ones (law of large numbers- just saying). This post is not simple- and will be difficult for a non-options skooled persons, but it should at least give one reason to not stick one’s private parts in a blender (e.g. trading options without the proper tools/knowledge).
I figured this would be one of those informational/discussion threads. THIS IS NOT ACADEMIC- this is real world options trading. Option theory and retail option platforms- yes even TOS- are “cool,” but they will still FUBAR your account.
I am first going to list some caveats for retail platforms and general option trading fallacies- many of which are found in one of my favorite math reads, Dynamic Hedging. Following that, I will discuss them- of course- that means charts from Volar.
Caveat A: SPX options are not the same as corn options.
Caveat B: Option skews, smiles, and decay term structures will rape you.
Caveat C: Not one, not a single greek, can be compared to another greek- even on the same commod on the same contract. This is a function of the “shadow greeks.”
What do I mean? Well first off each market will have a different smile- smiles affect option valuation paths. Secondly, and most importantly, IV is correlated (inversely) to price in SPX. This is why I have talked about call rape- but its more than that. Also SPX has no “carry” trades or spread trades, consequently, the only spread trading with options in the SPX is VOL time structure (think VIX/VXV). Whereas corn, spread trades do matter…spreads do change, and IV is not inversely correlated to price. Many do not understand that most commodity volume is actually spread volume (eg short JUL, long DEC). If you are playing options in a market where spreads move- you better be careful. A risk reversal calendar spread may have the correct direction, but horrible outcome due to shadow greeks. Even on the SPX, where there is no real spread changes, calender spreads (to capture net short theta, long vega positions), still cause havoc for traders without appropriate tools and experience.
Bottom line for caveat A: you have to have a model for each instrument. If your model does not account for correlations and spread differentials- well you are dead in the water.
Caveat B: Option skews, smiles, and decay term structures will rape you.
This chart is Corn IV over time. Clearly nothing is linear here. Notice that anything less than the 80% IV in the put tail of the first chart is not even readable in the second chart.
This chart is near expiration- yikes.
So my point is that the “VIX” is and “average” but averages the curve. The curve changes options differently. This is the largest reason for novice options traders failing- especially when they use TOS or retail option platforms. Sure your platform may give you a greek number, and even allow you to shift VOL, Time, and Price, but it wont model the IV smile term structure/decay. Toyota has breaks and a gas pedal, but it is not a Ferrari. Even if TOS did model IV term-structure/smile decay- how could you trust it when we know that each commod is different?
The smile affects option valuations over time. This is where things get hairy- shadow greeks. All retail models use BSM (black scholes merton)- but none account for the curve.
So let’s say one is short a JUL corn call (say 750 handle today). Delta may be -0.10 but that value only holds for today- technically for about 5 minutes. A typical model, presuming no change in price, will make about 3 (priced near 4 today) with 5 days till expiration (45 trading days from today). However, when adjusting for the smile (aka what volar code does), one will lose 3 cents. This is a 6 cent or 100% difference in valuation. Why? real world vs. academics. The IV for tails rises- there is no free lunch. Smiles occur for liquidity and “non- normal” distribution reasons. In any case, nobody holds till expiration, yet they make decisions as if they were holding till expiration. If one do not hold till expiration, one will not get expiration results. Many times OTM options (sold) will make one most of one’s money in 1 day- and waiting till expiration to capture a penny usually ends badly due to bid-ask differentials and IV premiums. Bottom line here- if one’s model does not adjust for reality.. one loses coin.
Now to further talk about how greeks are not comparable… spread trades… again.
Many think front month contracts decay more than back month. Some think the back months have more premium to sell and front months are relatively cheap. Neither is correct or wrong. Both are worthless ” all encompassing” statements- like most CNBC stuff.
A good option model should cover sensitivity to the following:
Here is the dilemma. Is one analyzing 1 day or 1 month? The changes are not linear and they change each other. And each change is multiplied by each other (negative or positive). Yes this looks like crap- but notice that delta is the linear slope of 1 point (chart below). This chart shows that vega moves opposite to decay, and that up gamma is not the same as down gamma. Also a gamma changes on a vol spike or time decay.
Ok so you see delta only matters at (1) a point in time (2) at a particular price (3) given a certain time (4) given a certain IV (Vol)
Now let’s look at an IV spike:
You can see the Curve is less steep, thus the gamma (delta change) is reduced.
Here is a time decay shift:
So… this goes to show that things change. Gamma up is not the same as gamma down. And gamma up for an OTM is utterly different than gamma down. Gamma (delta sensitivity) is inverse to Theta (time decay). The math is 1/2* gamma* (vol)*(Contract price^2). This implies that not ALL front month options, when adjusted for the IV curve structure, will not decay (example above). Secondly, one is exchanging decay risk for price risk.
Consider this with 2 options on two different contracts- each has about 20 moving curves at different rates.
This means one must manage the shadow greeks (bleeds, dvol dtime, ddelta dvol, etc…). Below are the ones I follow on a spread trade. BUT one must adjust this for the IV curve. So when I input the trades I know all of the shadow greeks and I model the IV curve. Also remember the spread may not move 1:1 with front month price….
Below are a list of Greeks and bleeds (or changes to greeks for a list of options). In all reality, scenario analysis encompasses all of this into one value, but one must be able to see what and why things change.
No, retail models do not do this correctly.
I suggest using heat maps for calendar spreads- once one adjusts for the code/IV smile of course. Here is a scenario map for 1 particular point in time. When one starts to analyze options, correctly, they will find that scenario analysis is the most optimal choice.
* test the good, the bad, the ugly. Never test the great. Stay frosty.
The top is the contract spread (JUL- DEC corn), the left is CN (JUL corn).
Here is 2 different vegas (price sensitivity to change in IV) for a JUL , DEC calender corn spread. Notice that front month VEGA declines relative to DEC. This means that those who “think” deferred options carry more “premium” is bull crap. The greeks are less sensitive- even though our above example showed that the IV smile spike/shift offsets the decay.
This means one must learn to trade the greeks and shadow (future) greeks. If one plans out the option scenarios one will find that most “common” ideas from brokerage houses are stupid.
So differed options have less sensitivity, but the gamma is higher and the theta lower.
Another stupid comment I hear is that 90% of option expire worthless. I must say logic like that is pure ignorance. (1) any 400% OTM option may or may not trade, consequently how do you even run stats on an infinite number? Secondly, if margin calls made one bankrupt 30 days before expiration (like MF global, LTCM etal), well expiration did not matter now did it?
Bottom Line: many think they are playing in the kiddy pool when they are actually swimming with a bag of meat on their back offshore Africa in shark infested waters.
Best of luck unbiased trading,
Happy new year, everyone. I don’t have much to say, so here is a picture that should sum up what I am seeing into January 20, 2012.
On the bottom (X-scale) is the percentage gains (rounded to the nearest integer) and the vertical scale depicts the number of occurrences. Remember that I mentioned opex median gain reversion strategies work best in the December opex period, and January follows as the closest second. Past January, there isn’t a lot of edge in this strategy until July opex period.
The expected value at which the SPX should target for its opex gain reversion is a close of 1239 on January 20 2012, but anywhere between 1177 and 1269 would have 80% probability. I, as an options seller, would love to sell covered OTM calls here and just pocket the premiums.
What’s interesting is the fact that there had been no prior occurrences at the 4.5% to 5.5% gain range in the past 41 years! We’re hovering around that range right now. Could we be filling in the statistical pothole?
Have a wonderful trading year during the year of doom,
When facing various setups in the tape I often ask myself: What would Livermore do? Believe it or not – quite often the spirit embodied by his work does point me in the right direction. Volar’s apt choice of the prior post’s title ‘Cover Short On Panic Days‘ is yet another popular mantra among seasoned traders credited to good ole’ Jesse. And nothing visualizes the concept of panic and fear like today’s VIX spike:
The spike to 32 yesterday was already way outside both my 25-day and 100-day Bollingers. Now both of them are set to a 2.0 standard deviation – I use this combination as it works very well for me. Of course there are other ways to stack your Bollingers – you could for instance use an increase in deviation from a standard 20-day moving average:
What we have here is a stacked 2.0/3.0/4.0 deviation from a 20-day SMA. And that push to 39.25 today breached the 4.0 mark. So, I ask you this – what are the odds for a push higher from here? I’m no math genius but I’d safely bet that it’s very low. The only issue that remains of course is what has driven the past few sessions: Yes, the odds are low but we still ride lower.
One aspect actually enabling that drop lower was the ‘bearish bullish candle‘ on Wednesday which I was (rightly) worried about. A push higher in an ongoing downtrend needs to catch a continued bid or it will fail and only serve as a ‘sell the rip’ opportunity.
The weekly SPX shows us that its 100-day SMA was touched and instantly repelled. The 1169.24 mark is now the line in the sand which must not be breached – if we do the expectation would be a visit of the 1000 mark.
Before I run – here’s the short term spoos chart. As you can see today’s NLBL didn’t have a snowball’s chance in hell to be touched. Monday it’ll descend down to 1258, still quite far up but closer in reach for next week. If you are more speculative then watch the hourly cluster around 1217 – 1219. Didn’t think we’ll see those numbers last week, did ya?
Rome wasn’t build in a day – but I concede it burned to the ground rather quickly. It’s quite possible that we drop further from here but we are not crap shooters – we are traders. The odds just do not support a short trade here and if you are mathematically inclined I strongly encourage to peruse Volar’s pertinent post (what is this – Batman?). I’m keeping my eye on those Net-Lines on the buy side but thus far we are still far off any type of confirmation.
The take away message here is one painful lesson fledgling traders hopefully learn before they get wiped out in emotional markets. Although the odds can be sometimes clear the cost of being on the wrong side of the trade can often outweigh the feasibility of a trade. For instance yesterday is a good example: Had you put on a long trade in the futures hoping that a 19:1 D/A ratio was reason to go long right away then you had been right on statistically but paid a steep price this morning (by now we snapped back).
As an anecdote of how strange and risky trading can be during volatile times take this: Had you been long call options last night you may actually have been fine, even during the drop this morning. Why? Simple – vega, which boosts your premiums when volatility spikes – like for instance this morning’s push to VIX 39.25. We are still above yesterday’s close of 32.07 and if you are holding naked long calls then I strongly recommend you take profits or leg into some type of vertical spread.
Yes, the trials and tribulations of trading the markets. But you got to admit – it’s a heck of fun if you get it right, and especially once you learn how to avoid those nasty cattle prods those market makers employ on a regular basis. On that happy note I part with you for the weekend.
Scanning through my momentum charts this weekend I see a pretty mixed salad – suggesting a continued low calorie diet for the bears. Some of my indicators claim it’s business as usual while others continue to show divergences pointing toward a possible correction looming in the not so distant future. But in summary I remain quite skeptical when it comes to the bearish case. The bulls are clearly leading the charge here.
I think the most stubbornly bullish chart is the VIX which suggest that complacency and faith in Bernanke’s put is at record highs:
For over six months now we have seen the bollinger band weave down and now our range has compressed to between 17 and 23 – that’s a whopping five handles. Back in the days we crossed five handles in a day. What’s really interesting however is the nature of the moves, which have largely contributed to a slow drop in the BB: Every time we hit anything resembling a buy signal the bears are literally being taken to the cleaners as volatility drops quickly in a matter of two or three days.
On top of price it is important to realize that volatility risk is quite considerable, especially for option buyers. Bear in mind that this affects both put and call holders. So if you think you can buy the dips with options and then reap the benefits on quick move up – think again.
There is an important chart however that stands in stark contrast with the VIX:
Obviously the 5-day MA looks a bit more bullish right now but still – there is a distinct divergence developing here which I believe needs to resolve itself eventually. Unless of course we are going to gyrate around for the next six to eight weeks, thus producing a ‘sideways consolidation’ and giving the bulls the momentum to take 2011 by the horns in January.
For an example of just that look no further than May 2009 – we had a similar pattern emerging and in the end we never saw much of a correction and bears got slaughtered. Granted – this is not 2009 and we are in a much narrower and controlled market now. But when I look at this divergence and compare it with recent patterns then I’m a bit surprised to not see at least a drop to SPX 1100. So given that perspective it’s quite disturbing that the bears cannot muster up more of a reversal here.
The NYMO:BPNYA ratio chart tells a similar story. Without much downside in equities we quickly found ourselves at what seems to be a new buy line for this current leg higher. If the bears can turn it around here we may actually see a real drop but if you contrast this chart with the VIX for instance then the bears would literally have to come out of the woodwork to force a reversal – no pun intended.
And if there is any chance for a bearish scenario – short or medium term – then it’s probably right now and here. My BB on the SPX was quite clear about an impending drop – which is what we got. And now we are back at the center line and the magic 1200 mark. In my opinion – once we are above that it will be extremely hard for the bears to steer the ship back down – so if it is to be it must happen on Monday.
Bonds have been really interesting as of late – especially on the long term yield side. The 20-year (shown via TLT) got smacked big time and found itself embedded below the 20% mark on my stochastic. It seems to want to breach however and I expect a little reversal here momentarily. If it happens I think the 100 mark should be well in its sights.
Finally the daily Zero – which is getting interesting. Yes, thus far it has kept us out of becoming overly bearish – or bullish for that matter. However, things are slowly shifting and I expect ‘something significant’ to happen by early January. Look – the channel I painted on the smoothed panel needs to be breached – either up or down. Because if equities keep riding higher with the smoothed signal remaining below the upper channel line then we are talking about a bearish divergence, which can be ignored for a while but not ad infinitum.
Of course – if the DZ pushes higher and above the zero mark then it would strongly suggest that any dreams of a meaningful downside correction should be abandoned until 2011.
I’m mostly in cash these days as I the upside risk (see VIX) is growing but downside risk also remains considerable. It’s the type of tape where I keep telling myself that there is nothing wrong with watching and only taking small positions. Of course we could see a blow off move to the upside – considering the potential for a seasonal Santa Rally I could be missing out on a big move up. But is it worth the risk?
Perhaps Monday we’ll get that answer. Looking at the charts above I think that now would be the time for the shorts to come out and drive the tape lower. Chances are that after Thanksgiving the train pretty much has left the station. And momentum usually remains with whatever transpired ahead of the holiday season.
There is however another thought that occurred to me – grant me a little thought experiment (i.e. mental masturbation). Let’s say we actually drop on Monday or Tuesday – how far will it really get us? There is a cluster of support starting at 1130 and the thin tape during the Christmas season would most likely not lead to a breach through all those support lines. But let’s just assume we drop though that as well and find ourselves again near 1040 in January. What do you think would happen? A complete take down in January? Or an instant snap back as institutional dip buyers get positioned in the near year?
As strange as it may sound – I don’t think this is the time for the bears to make a move. It’s probably best to let the bulls have their Santa Rally and push equities to new record highs. From there an attack must be forged – one that produces long red candles slicing through entire clusters of support in a matter of days. I don’t think this type of ‘condoned downside’ we have seen as of late has the type of mojo capable of posing a real threat to the longs. More likely these are continued retail pig shake outs and thus buying opportunities for the big boyz.