Jimmy! We’re Stuck in a Market Maelstrom! (GDX,DIA)
That’s the way bookie fumbles, folks.
You enter the casino either as an oddsmaker or a bettor, and it doesn’t matter which – in both roles you run an equal risk of exiting a loser.
And that’s the lesson of the last week in equity markets, too, a period that witnessed volatility jump from near record low levels to VIX 50 yesterday! A 1600 point drop on the Dow also made history.
Yet the masses still don’t understand the nature of the beast.
If sentiment levels are any guide – and they should be, because that’s the only thing that’s truly guiding markets these days – we’re still in for a wham-doggy selling event in the weeks ahead, one that could make Monday’s six percent intraday decline look like a drugged out monkey on a 70’s sitcom.
The total decline from the top registers at slightly more than 10%, qualifying as a ‘correction’ for those who like to define these things by the numbers. But while many believe there’s more to come, the market’s follow through on Tuesday provides near term hope for the bulls.
It appears that both the volume of selling and initial sentiment indications are pointing toward a bounce in the days ahead.
Yesterday began the process, but how far it carries – as we’ve stated repeatedly – has everything to do with how giddy people get as we approach overhead resistance. Should the mood be all smiles and balloons, watch out. Should we catch a whiff of death in the room, however, we’ll know that the bull is still alive.
Let’s start with a look at just how powerful and quick that explosion of volatility was.
Below is a chart with the raw VIX numbers in historical perspective.
As you can see, we’re at extraordinary highs, and the question on everyone’s mind is whether we’ll see sustained volatility at these levels. Yesterday’s action pacified markets appreciably, sending VIX readings crashing back from over 50 towards 20.
But that’s just a single day, and our feeling is the unwind here could take weeks to play out, during which we’ll see lots more VIX panic.
Take a look now at the VVIX, a measure of how volatile the volatility index is!
Many view the VVIX as a quantitative superfluity, claiming that as a derivative of a derivative it represents navel gazing at its best. But we disagree.
The explosiveness of a market, the speed at which it moves from calm to panic, as well as the dimensions of that panic are, to us, valuable sources of information. The VVIX measures precisely how tightly wired investors are. That is to say, when things start to go awry, we’re given a picture of how quickly the men and machines that do the trading out there are prepared to throw in the towel.
And as the data suggests, we’re currently at the highest level of ‘trigger-happy’ that we’ve seen at any time since data for the series began being kept.
The Need for Insurance
Perhaps more than anything else, the action on the markets over the last couple of years, taken together with that of the last few days, prove beyond a shadow of a doubt that we are fully ensconced in the final stages of a bull market that many believe spans more than just the last decade.
The melt-up action that brought us to this stage has seldom been seen before , though we were offered glimpses during the NASDAQ’s dot.com bubble of 2000.
Today’s rise, however, has the hallmark of a culmination of something more profound, something that goes back much further, to 1980, or, as some aver, all the way back to 1929, and marks a secular end not only to this bubble phase of equity enthusiasm, but more broadly, to the very financial experiment that began with FDR’s creation of the modern American welfare state and the endless borrow and spend treadmill that was created thereby.
And depending on where you mark that beginning, so do you measure the commensurate fall to come.
Dow 16,000…? Or 1600?
We’re not going to delve into the whys and wherefores of where things might one day end up. We still have the coming top to contend with, and, of course, the numerous Jack and Jill tumbles – like that of the last week – that are in store as we come to that top.
And so we offer another chart, courtesy of Bloomberg News, that indicates a ‘selling climax’ may already have occurred, and that we’re very likely in for a short term bounce.
The New York Stock Exchange registered a 93% downside volume read on Friday – the heaviest selling since 2016, and a number “consistent with past bottoms”.
We like that indicator and are prepared to use it alongside the softening VIX numbers to set up a trade for the week.
But first, let’s look back on a couple of open initiatives.
The first was launched on January 4th in a letter called New Year In, Same as the Old. There, we urged you to sell The GDX February 2nd 24 PUT for $0.78 and the GDX February 2nd 23 CALL for $0.91. Total credit on the trade was $1.69.
Last Friday, GDX closed at $22.91, triggering the 24 PUT and making us proud owners of a single lot of stock at that price.
With the shares now at $21.80, though, we find ourselves in the hole $0.51 (2.20 less 1.69), so we’re selling the GDX June 15th 22 CALL for $1.38.
Next up was our January 18th initiative from Out With the Old, wherein we encouraged you to buy the DIA March 2nd 265 CALL for $1.91 and the DIA June 29th 227 PUT for $2.09. Total debit was exactly $4.00.
Subsequent to that, on February 1st, we sold the CALL for $2.02, and today we’re selling the PUT.
The June 29th 227 goes for $4.45 – unload it and you walk away with $2.47 net on $4.00 spent, or 61%, in just three weeks.
We expect the aforementioned bounce on the indexes to carry the Dow, as represented by SPDR Dow Jones Industrial Average ETF (NYSE:DIA), as high as overhead resistance at 255 (see below). And it’s there – and at support – that we’re selling a diagonal strangle.
Take a look –- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]
Many happy returns,