Volapiphany

Once again equity indices have become stuck near important inflection points, which incidentally in my book are key thresholds from which shifts in momentum and trend changes can be triggered.

No matter if you are bullish or bearish – this will most likely be the most important update of Q1 2019. So it’s once again time to forget about the daily noise, take a few steps back, and look at the market from a 10,000 foot perspective.

I actually didn’t even mean to post a momo update today but I was toying with some of my volatility chart and came up with a short term goodie I’m sure many of you will appreciate going forward.

It’s a chart of the VIX vs. the VXO, the latter sometimes being called the ‘old VIX’. A little history: Until a revamp in 2003, the VIX was based on OEX options, but CBOE ultimately decided to switch to SPX options to provide a broader sampling of volatility expectations.

Why? Because in order for a futures market to function, the market makers need to be able to cost-effectively hedge their positions.  Hedging the 1992 version of the VIX required frequent rebalancing of SPX options that was too expensive to implement.

Undeterred the CBOE introduced version 2 in 2003. The new methodology allowed market makers to hedge their positions with a static portfolio of SPX options that could be held until the VIX futures expired. VIX Futures started trading in 2004 and in 2006 options on VIX futures were rolled out.

So basically what’s happening in the chart above is that we are correlating two different sample sets: one produced by a narrow set of OEX options and one by a much wider set of SPX options.

What comes out the other end is a volatility ratio that is reminiscent of market breadth. And clearly there’s something to it as the red and green lines I’ve drawn mark important exhaustion points. Note that I am not calling them reversals as prevailing momentum can often push price far beyond what any indicator may claim.

That said breaches > the upper BB and below the lower BB seem to be useful in scaling out of trend trades. And can in correlation with various other technical mesures be useful for getting positioned. Speaking of which, let’s get to the momo update:

Let’s start with SKEW in relation to VIX, which IMO is a much better gauge of market momo than either on its own, but especially the vanilla SKEW. I have refrained from pointing at possible lows here as the BB has been falling and continues to do so.

What I’m mostly interested in right now is the falling diagonal resistance line that now extends into 6.6 on the ratio. It’s been rejected three times and the last one resulted into a big slide lower from SPX 2800.

We’re getting pretty close here and if this happens a fourth time then there won’t be a dry eye in the house, and I’m not talking about tears of joy either.

Next runner up is the VIX:VXV which I should rename VIX:VIX3M but I don’t wanna. I think my comment on the chart is pretty clear. The 0.92 threshold is where the bulls can start hedging faint hopes for a green spring. A reversal higher from there spells very bad medicine for the remainder of this quarter.

One more before I’ll have to drop below the pay wall but I’ll make it worth your while. First up we are looking at NYSE market breadth here and the 100/1.5 BB has treated us very well over the years.

Something to note however are large spikes in the ratio, which can eventually trigger another drop in price if markets continue to push sideways after they occur. So nothing to be worried about right now but if both January and February remain flat then I suggest you prepare for another leg lower.

In the past those final legs lower have been relatively mild, but of course we were in a completely different market phase, so let’s not jump to conclusions.

Alright, a ton more waiting below the fold:

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Public Service Announcement: This update too me quite a few hours to put together and I’ll have to catch up on some internal chores tomorrow. So no post on Tuesday and I’ll be back on Wednesday.