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Something strange is happening in the market right now

In the past few days, the S&P 500 (SPX) has risen to all-time highs. I mean, that’s strange given our current economic back drop. But that’s not what I’m talking about.

What’s strange about the current state of the market?

While the SPX is at all-time highs, the volatility indices have been rising as well. These indices include VIX, VVIX, and VXX.

If you don’t know what these are, that’s okay. VIX is an index that tracks the implied volatility of the SPX based off how the options for that index are priced. It is what the one month expected move in the market is, in a sense. VVIX is an index that tracks the implied volatility of VIX based off how the options on VIX are priced. VXX is an index that tracks the volatility based off the weighted balance of the first two VX futures contracts which trade.

For now, let’s focus on VIX. On August 25th, VIX closed at 22. As of today’s close on August 31st, it is 26.4. In percentage terms, VIX was up today 15%. (Many people don’t like quoting VIX changes in percentage terms — I don’t care).

In 3 of the past 4 days, we have seen VIX close higher than where it opened. This has happened all while the SPX has hit all-time highs in each of the past four days.

VVIX — also known as the volatility of volatility — has shown a similar trend to VIX, rising in 3 of the past 4 days. VXX — which is based off the front two months of futures contracts on VIX futures — has also steadily risen and shown similar trends.

Realized volatility is far below implied volatility options are pricing in

The volatility that is implied by SPX options is much higher than the realized volatility we’ve seen in the past 30 days. According to my calculations, realized volatility for the past month has been under 10%. Meanwhile, VIX has held strong above 22, and has continued to climb in recent days as noted above.

Why is this strange to me?

In general, you tend to see VIX fall as SPX rises. In general, there is an inverse relationship between these two items.

Today, VIX rose by 15% while SPX fell by roughly 0.3%. According to my data, this has only happened 5 times going back to 1993.

vixspx 8-31-20

Note: The above chart is in percentage terms.

I’m not the only one that has noticed

Mark Sebastian, from OptionPit.com and frequent guest on The Options Insider Radio noted the following:

sebastian 8-31-20

What he is saying here is that there is a huge difference between the volatility being priced the NASDAQ 100 Volatility Index — VXN — and the S&P 500 Volatility Index — VIX. This is interesting to me because the NASDAQ 100 is composed of non-financial companies and is weighted heavily towards those tech stocks. The very tech stocks which have been going parabolic in recent weeks (some may even say months).

In addition, Matt Thompson noted the following:

thompson 8-31-20

The 5-day average contango, which is merely the difference in the implied volatility priced in by the front month futures contract and the second month futures contract is at 16.9%, which was at the 99th percentile since 2004. Also he noted what I noted earlier, that the VIX is much higher than the realized volatility on SPX.

What does this all mean?

This could mean a number of things. Ultimately it means there is a lot of uncertainty in the market, and options are pricing in more volatility than the volatility that we’ve witnessed in the last month.

This could mean that big money is hedging their positions with put options on SPX or call options on VIX or buying VX futures, all of which could cause the premiums paid to rise.

In addition, the VX futures for October are pricing in extra volatility due to the upcoming election. The pricing of these October futures remains elevated when compared to the September and November VX futures prices.

vx term structure 8-31-20

Investors are nervous about what could come in the next month or two. And they have good reason to be.

There is still no agreement on extended economic stimulus that the American people desperately need. Republicans and Democrats have still not agreed to a deal. As of the last update I saw, Republicans proposed a $1.3 trillion stimulus, which was rejected by Democrats. The House, led by Democrats, passed a $3 trillion stimulus back in May. They said they would be willing to lower their demands to $2.2 trillion. No deal is in sight, and that could have investors spooked.

Fact is, we are in a bubble

The last time market closed at all-time highs with VIX this elevated was during the late 90s tech boom. That was a time period which also coincided with easy Federal Reserve monetary policy and high speculation in stocks.

We are seeing similar behavior in the tech stocks and work-from-home stocks today. Apple, Amazon, Google, Facebook, Tesla, Nvidia, Zoom, and AMD are all examples of stocks which are booming right now.

But the pain for the American people is far from over. Continuing claims continue to remain above 14 million. The unemployment rate is over 10%. The economy is attempting to recover slowly. But stocks? They’ve ripped to all-time highs at a much more rapid rate. And the disconnect between those two has investors nervous right now.

Dark pools are not buying this rally anymore either

In order to understand what’s happening, check out the Dark Pools. According to the Dark Pool Index over at Squeezemetrics.com, Dark Pools have printed under 45% for 17 days in a row. In general, a print over 45% is considered to be bullish, and there tends to be a slight lag between dark pool prints and stock market returns.

dpi

This is meaningful to me because Dark Pools bought the rally all through April well into July. But they aren’t buying anymore.

Perhaps we will begin to see a return of selling to the market in the coming days or weeks. I know I’m on high alert for that right now and will be ready to short this market when the opportunity presents itself.

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Author: Trader Court

CPA first, pivoted to python programmer focused on data science which I apply to my own stock and options trading.

2 thoughts on “Something strange is happening in the market right now”

    1. Thanks Jeff. I’m feeling uneasy now too, especially because things seem to have gotten so frothy.

      Also just wanted to say thanks for sending me the spreadsheet that you use — It’s very well designed. Thanks again for sharing!

      Liked by 1 person

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