A dark green day has turned into one plagued by uncertainty after the indexes have given up just about all of their gains and are hovering near their lows for the day. I pointed out last night as 1,649 being the level to focus on and once SPX failed to hold onto it with stability the pullback began. Making matters worse for the bulls, they weren’t able to hold onto the 1,640′s and are back below the key 1,640 level. The focus for the rest of the day and tomorrow is last weeks lows in the high 1,620′s, call it 1,627-1,630. The bulls have to hold that range and get a close back above 1,640 (ideally today) in order to have me thinking a 1,600 test is off the table.
One thing I found interesting this morning was the action in the VIX, which at its low for the day was down about 5%. Given the enthusiasm behind the gap up, and the rallies in foreign markets, my natural inclination was that the VIX would be down 10% at the open. Shortly after the open, the VIX was down a much more respectable 2-3% and it remained that way until eventually going breakeven/slightly green as SPX got closer and closer to 1,640. I interpreted the VIX action as the market not trusting the rally and using the opportunity as a chance to buy cheapened protection by purchased SPX puts, which lost value due to the gap higher.
One could’ve argued at the time that that was a contrarian bullish signal that could have propelled the market. However, we know obviously now that that wasn’t the case. But, that doesn’t necessarily mean the argument doesn’t still apply. Bulls should be encouraged by the fact the VIX did not fall sharply on a 100 pt down day. Why? Because even though I am still a believer in a 1,600 test, action like today’s in the VIX tells me that if that does play out, market participants will be properly positioned as to not panic when that level is being tested.
If the market is willing to keep the VIX elevated by purchasing SPX puts it means they are starting to hedge their long positions against a continued market pullback. That will make any pullback easier to stomach should it play out. If that pullback doesn’t play out, then the open put interest on out of the money SPX put options will create an element of support that might not otherwise be there. My bottom line? Below 1,640 I remain immediate term bearish but seeing VIX action like today has me thinking that 1,600 might be as low as we go as opposed to somewhere in the 1,500′s.
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