Yesterday the markets caught a little whiff of fear, and entered what I call a short-term "decline phase" of sentiment. That means the VIX saw some upward momentum, with the prevailing sentiment mood -- in the very short-term, mind you -- moving towards rising fear. This is usually associated with market sell-offs, as the fear impulse -- as evidenced by a rising VIX -- generally stirs a desire among market participants to pare back long exposure.
The hallmark of this recent "mini-bubble" has been the market's ability to shrug off these short-term decline phases, and for the VIX to not really get any traction to the upside. Fear has not developed in any significant way. In other words, there hasn't been a short-term decline phase that has turned into an mid-term decline phase of any significance, which is beyond remarkable. It's downright aberrant. Many are interpreting this aberration as proof that the mid-term decline phase has been officially abolished -- a very dangerous notion, to be sure. The market's task soon will surely be to dis-abuse the majority of this "bulletproof" feeling.
Everybody following along on the Rydex/SPY positions should now just go completely flat, if you haven't done so already. There's no sense betting on the upside or downside right now, since we're trying to catch a big sentiment shift leading to a juicy mid-term downside move. In the short-term, we need to see if this decline phase can "get legs". That will be the first sign of a potential mid-term selling squall developing.
The thing to watch for will be an acceleration in the VIX to the upside, and another daily white candle.
That will show some real developing fear, and from a very, very low level. So I'll repeat it for the thousandth time: a mid-term correction from these levels of bullish sentiment can be a whopping move to the downside.
Since we're on the subject of the VIX (no surprise!), there was a very interesting announcement from the Chicago Board of Options Exchange that they are going to launch futures and options on the VIX, starting some time in the fourth quarter of 2003. This is really great news, well, at least I think so.
The VIX doesn't move like other underlying financial instruments, in that it doesn't trend. It oscillates. This gives it a little more predictability in its behavior, meaning if it's low, it tends to oscillate back up; and if it's high, it tends to oscillate back down. Obviously it's not a perfect sine wave -- but it is remarkably anti-persistent. That should make the VIX a very rewarding vehicle to trade, at least in my humble opinion.
There is also going to be a change in methodology in the way the VIX is computed, starting later in the year. The old VIX based on the S&P 100 (OEX) will still be computed and published, but the "new VIX" will be based on S&P 500 (SPX) options -- which have grown to dwarf the OEX in terms of volume and open interest. So this makes sense for the main, headline measurement of implied volatility to migrate to this bigger market.
However, it remains to be seen whether this new VIX will be as valuable as the current one. (Remember "New Coke?") You see, there is a MAJOR difference between OEX and SPX options. OEX are "American-style" options, which can be exercised at any time prior to expiration. SPX options are "European-style" and can't be exercised early. This is an important distinction because it means that very few traders ever write (sell) OEX options, as the margin requirements are much heftier when you write American-style options. It's almost always a market maker that is writing an OEX option.
So perhaps the VIX is so valuable because it's a "pure read" on the sentiment of traders that want to buy options. It's a great gauge of supply and demand on the buy side, which is important -- at least I think so. In the SPX options arena, the seller could be any institution, hedge fund, or individual executing any variety of options strategy, and it could lead to some less valuble data.
So we'll have to see whether this new VIX is as useful for market timing, which will take some time to figure out. I'm just thankful they're continuing the "old" VIX -- to be under the new ticker symbol VXO -- and hopefully fewer people will now pay attention to the implied volatility on the OEX.
That could be a very good development indeed, if this turns out to be the case. Hopefully the implied volatility on the OEX will fade from the mainstream consciousness, which can only enhance its value for those that still want to follow it closely.
Sentiment Dashboard
by Adam Oliensis
SENTIMENT TANK: Filled 2 points to 2% full of negative sentiment.
SHORT-TERM: Hourly gauge is still in neutral with a negative slant, turning down toward a decline phase.
MID-TERM: Progressed 2 points in its advance phase to 76% but Confidence dipped a point to a bullish 2 (out of 7).
LONG-TERM: Weekly gauge remained unchanged on the day at 98% on the advance side but with Confidence also dipping a point here.
BOTTOM LINE: The tank worked as it's designed to. When it hit 0% we got a selloff. Not much of one yet, however. Is this the start of a bigger decline? Too soon to say.
Bullishness is now ubiquitous. It's probably true that mid-term fundamentals (WENDI, earnings growth, and low interest rates) will support stocks for the balance of the year (longer-term overhangs notwithstanding), as does the weekly gauge's refusal to roll over into a decline phase. But many have accrued large profits since March, and their conviction has not yet been tested. Also, it is the exception rather than the rule to get through the September-October Earnings Warning season and Mutual Fund year-end season without at least one significant selloff. Any way you turn the technical kaleidoscope, this market is wildly ripe for at least a short-term purge. Something to help blow the froth off the top of the beer.
Se não receio o erro é porque estou sempre pronto a corrigi-lo
There's no bull side and no bear side. JUST THE RIGHT SIDE!
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