The VIX is trading above a trendline that is connecting lower highs since mid-September
“On Friday, the VIX closed north of its short-term 30-day moving average, and its longer-term 252-day, or one-year moving average. Both moving averages have provided guidance in forecasting volatility in recent months. But crosses above and below have been less meaningful this month. Monitor the VIX closely, as consecutive closes above these moving averages should put you on alert that higher volatility is ahead, contrary to my thinking from last week. A VIX close above the trendline connecting lower highs since mid-September could be used as a tool to confirm that higher volatility is imminent.”
- Monday Morning Outlook, October 19, 2020
The Cboe Market Volatility Index (VIX -- 27.55) remains above two key short-term (30-day) and long-term (252-day, or one-year) moving averages as we enter this week’s trading. But as I mentioned last week, there has more been more back and forth above and below these trendlines than in the past, suggesting traders should still be on the alert for higher volatility, but also look for a confirmation.
One confirmation measure I said could be viable is the VIX trading above a trendline that has been connecting lower highs since mid-September. Last week, the VIX toyed around with closes above this trendline, but at the end of the week, it closed below it. It is interesting that the moving averages that I mentioned above are currently situated around 27.56, which corresponds to double 2019’s close of 13.78.
Another confirmation tool you can use to conclude that the risk of higher volatility ahead is growing is the continuous front-month VIX futures contract (/VXc). It is our view that the failure at its 200-day moving average and the inability to overtake the 30 level last week reduces the odds of a volatility spike that is being forecast right now by the VIX being north of its 30-day and 252-day moving averages. The 29.26 level corresponds to the round 100% year-to-date gain for the contract, and there was a failure to overtake this level last week.
From a big picture perspective, the VIX might be considered elevated, as the S&P 500 Index (SPX -- 3,465.39) is slightly higher on the year. However, volatility expectations for the next 30 days are double what they were coming into 2020.
Since January, analysts have warned that election-related volatility is being priced into options and volatility futures, but as I suggested two weeks ago, it appears that while certain assets are priced for looming volatility, market participants are not positioning as such. But this comes as no surprise, because this 30-day volatility measure incorporates elections that are now less than two weeks away. In fact, VIX futures option buyers, who have historically had a good track record with option purchases, and who were correct ahead of the volatility event earlier this year, have been making a noticeable bet on lower volatility during the past month.
Per the chart below, note how the 20-day, buy (to open) put/call volume ratio has surged above 1.0, to its highest level since October 2010. When put buying on VIX futures is at or above 1.0, historically, it has preceded lower volatility, which is something to keep in mind.
“The idea is to have a short leash with respect to the lower volatility, higher equities trade. While this trade got off to a good start last Monday, it is not yet broken. But then again, it is not looking as promising either.”
- Monday Morning Outlook, October 19, 2020
Above are my concluding comments from last week, with the “not as promising” phrase due to the VIX’s close above the 30-day and 252-day moving averages. While the VIX remains above these moving averages, a risk to the lower volatility and higher equities case is still in cards during the next month. I was happy, as a contrarian, to see active managers pull back on their long exposure last week. And this occurred with very little damage to equities, as the SPX remains above its February 2020 closing high, and the Russell 2000 Index’s (RUT -- 1,640.50) hit a low last week was at 1,600 -- a level that had previously acted as resistance on several occasions.
Finally, I will leave you with this excerpt from a Bloomberg article that I noticed on Friday. Since so much of this week’s commentary was dedicated to volatility and where it is headed, I thought this perspective was very worthwhile in the context of the discussion above.
“While the Cboe Volatility Index -- the equity market’s ‘fear gauge’ -- hovers around a still-elevated reading of 30, corporate bond spreads have been steadily grinding back to pre-pandemic levels. That’s opened up a rift between the VIX and investment-grade spreads, which tend to loosely track each other…Financial Enhancement Group’s Andrew Thrasher has a different interpretation. While the two measures have drifted apart, there’s no guarantee that spreads will widen to meet the VIX, he said on Twitter. Rather, such dislocations tend to result in lower equity volatility, with spreads being ‘right.’
- Bloomberg, October 23, 2020
Todd Salamone is Schaeffer's Senior V.P. of Research
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