The S&P500 is busy testing key support at 1,620 this morning and the “fear trade” is in full effect as the VIX is higher by 7%. Since May 17th the VIX has rallied 40%+ and is now trading at its highest level since April 18th. There is a major difference between today’s level in the VIX and the one seen on April 18th, the corresponding level in the SPX itself (which remember it is options on SPX that actually dictate the price of the VIX). On April 18th, SPX was in the 1,540′s. My takeaway is you should be cautious of buying into the fear this close to a key support level like 1,620.
There have been 3 times this year where the VIX has moved above 17: late February, mid April, and now. The two previous times ended up signaling bottoms for the indexes. In trying to determine if there is anything different this time around compared to those two times, I can’t yet say there is. That is why I favor the long trade here vs 1,620 instead of the short trade. What would change my mind? The same thing I’ve been waiting for all year, 3 days in a row where SPY closes below its opening price (if SPY closes today below $163.83 it will be the 2nd day in a row it closed below its opening price).
The VIX is a counter-intuitive study because when it rises it means volatility is on the rise, and volatility historically has been associated with lower prices. However, you have to consider the context in which the VIX is rising before including it in a bearish thesis. The context of this latest move is that the VIX has already seen a remarkable 40% rally, but it didn’t even take SPX more than 4% away from its all time high or below (what I believe is) key support at 1,620. That’s why I’d rather get short SPX at 1,619 instead of 1,621 because in my view then I could trust the volatility the VIX is signaling is coming to take the market lower because it would be in conjunction with a key support level breaking.
I emphasize that 1,620 level because most people forget volatility works both ways: the higher the VIX is, the wider range SPY is likely to see on a daily basis. The implications of that as long as 1,620 holds is for a rubber band snap back like rally back towards 1,640. If the market was to rally towards 1,640 would you rather be short here, or long? The obvious answer is long. If the market doesn’t rally but instead breaks down at 1,620 would you rather have been short with greater certainty at 1,619 or short with less certainty at 1,623? I prefer the first option.
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