VIX futures spread has reversed course and is now in decline
In perhaps the understatement of the century, there is an important election coming up. One must assume then, that volatility has been through the roof these last few months leading up to November 3. Instead, the equity market’s “fear gauge,” the Cboe Market Volatility Index (VIX) has not closed above 30 since Sept. 8 and hasn’t breached 24 on a closing basis since Aug. 28. This flatlining has created a tidy little channel with the 200-day moving average up top, and the 50-day moving average on the lower rung. But this consolidation has certainly been perplexing for options traders that were bracing for rampant volatility leading up to the election.
Does this mean market participants are simply sitting out the coming months? Far from it, it seems. Last week, Schaeffer's Senior V.P. of Research Todd Salamone had this to say about the VIX: "during the past 20 trading days, buyers on VIX futures options have purchased more puts than calls. In other words, the bet is that volatility will head lower. This is extremely unusual because typically more calls are purchased than puts." Given everything the investor has gone through in 2020, such an assertation is noteworthy, especially less than two weeks from one of the most important elections of our lifetime.
Todd later ascertained that "with active investment managers now fully invested like they were in August, and net shorts on VIX futures now exceeding 100,000 contracts, the lower volatility bet might be getting too crowded." A closer look at volume sets off even more alarm bells. The 20-Day VIX put volume has now surpassed 20-day VIX call volume. Put volume has surpassed the one million mark, while call volume has declined below 650,000 contracts cumulatively over past twenty days. Per the chart below, the 20-day call/put ratio (in black) has been in a channel between 1.0 and 2.0 since the onset of the pandemic. That channel has now been broken, with the ratio last seen extending its recent decline to 0.63.
It’s an odd time to bet on lowered volatility, but it doesn’t necessarily suggest a contrarian strategy is being deployed. The political landscape today is a volatile as its ever been, and that often translates to stock market volatility. Even though virtually every poll and pundit have former Vice President Joe Biden sizably ahead, 2016 should serve as a stark reminder in how much stock to take in polling. In other words, a prudent investor should be clued into what the VIX could do in the coming weeks. Schaeffer's Senior Market Strategist Chris Prybal was able to extend the Monday Morning Outlook VIX chart to encompass all of 2016. As you can see, the call/put ratio spent November 2016 nestled in that 1.0 and 2.0 channel, but the discrepancy with the VIX was not nearly as sharp as it is now.
Why does this even matter, if the VIX is only just a "fear gauge?" In terms of asset class performance this year, VIX leads the pack, up 101% year-to-date and with a 79% 12-month gain. For comparison, that year-to-date total is triple the asset class performance of the Nasdaq-100 (NDX). The year 2020 has been a banner one for volatility, but with 2021 is less than three months away, what does the VIX and its players have for a crescendo?
Per the chart below, the VIX futures spread (concerning front-month and second-month contracts) has reversed course and is now in decline. Using the VIX’s 20-day average as a proxy, the spread is coming off its largest reading on record. Plus, looking at the S&P 500 Index (SPX) white line, a correlation is starting to re-form with the VIX futures slope. It’s important to remember that this doesn’t necessarily articulate contrarianism in action, but all of this jostling and betting against the VIX and volatility will be one of the more interesting stock market trends to follow as 2020 delivers its final blows.
Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, October 25.