MW How the presidential election is playing havoc with stock-market volatility
By Lawrence G. McMillan
The VIX is getting jolted as Election Day nears
The S&P 500 Index SPX has shrugged off the negativity of late September and hit a new all-time high. The breadth of the market is not necessarily following suit, but this is bullish confirmation for the chart of the index itself. There is still support in the 5,670 area, and a close below that would be a cause for concern. The "target" remains as the +4<SIGMA> "modified Bollinger Band" (mBB), which is now at about 5,840 and rising.
The McMillan Volatility Band $(MVB.AU)$ buy signal (green "B" on the accompanying SPX chart) remains intact. Its signal would be fulfilled if it reaches the target of the +4<SIGMA> Band.
The equity-only put-call ratios continue to decline, since put buying has been lacking while call buying has been heavy. This action has forced the ratios down toward the lower regions of their charts - which means they are in overbought territory. However, they will not generate sell signals until they roll over and begin to rise sustainably.
Market breadth itself has been rather weak in the past several days. In fact, a breadth oscillator sell signal has been confirmed for each of the "stocks only" and NYSE breadth oscillators. NYSE breadth continues to be somewhat stronger than the "stocks only" breadth, but even it only registered very modest positive breadth over the last two trading days: the first of which saw SPX rise by 56 points, and the second of which saw SPX make a new all-time high while rising another 40 points. So, this is a negative warning currently.
Cumulative volume breadth $(CVB.AU)$ has continued to make new all-time highs as well. This is a strong confirmation of the new highs by SPX, which also means there is not a negative divergence in place at this time.
New highs on the NYSE have continued to outnumber new lows. That means this indicator remains solidly bullish. It would only relinquish that status if new lows were to outnumber new highs on the NYSE for two consecutive days.
VIX VIX continues to rise. Part of this is due to what we call the "election bump" (see the Market Insight section). Regardless, the trend of VIX sell signal remains in place because VIX is well above its 200-day moving average $(MA)$, which is currently just above 15 and rising slowly. In addition, the rise in VIX has placed it in "spiking" mode, and as a result a "spike peak" buy signal will eventually occur. VIX would have to close at least three points below its most recent high in order for that buy signal to be confirmed. At this time, the most recent high for VIX is 23.14, on Oct. 8.
The construct of volatility derivatives remains mostly bullish for stocks. The term structures slope upwards, with the exception of the October and November VIX futures, which are elevated because of the expectations of post-election volatility - the "election bump."
We are retaining a "core" bullish position as long as SPX closes above 5,670. We will trade other confirmed signals as they appear, and will continue to roll in-the-money positions to lock in partial profits.
Market insight: The election's effect on volatility indicators
The "election bump" is how I describe the distortion in the term structure of the VIX futures prices. Specifically, the October VIX futures continue to trade above the prices of the November and December futures.
The reason that October VIX futures are so elevated is that they are based on the prices of the SPX options that expire on Nov. 15 - just after the election. As with any event that is perceived to be a generator of volatile price action, the options that expire just after the event will be high-priced in terms of implied volatility, and the other option series that follow out in time after that will also be trading with a somewhat elevated volatility, though not as large as the near-term one.
Personally, I don't see why the election would necessarily cause a volatile stock market move (it normally does not), but that is the perception in the market at this time.
The "election bump" was not affecting the price of VIX until this past week, when the election drew within 30 days. At that point, the VIX calculation began to take into account SPX options that expire just after the election, and those are inflated in price. The "election bump" is also visible in the CBOE Volatility Indices (VX00), although perhaps not as obviously. There is a large discrepancy between the nine-day VIX (VIX9D) and the price of VIX. VIX is much higher than VIX9D and is much closer to the 90-day VIX (VIX3M). That's where the "election bump" shows up in this data set.
So, can we take advantage of this? It might seem like an obvious trade to sell October VIX futures and buy another VIX futures contract expiring later. That won't work because the October futures expire on Oct. 16, before the election. So, on their expiration date, the options on which they are based (SPX Nov. 15 options) will still be expensive and thus so will October VIX futures.
What about spreading the next series? That is: Sell November VIX futures and buy December VIX futures. That could potentially work out but such a trade is only for futures traders who understand the risks of futures calendar spreads - and not for the average speculator. If the stock market were to plunge after the election, that futures calendar spread could mark down by a great deal.
New recommendation: Potential 'spike peak' buy signal
This recommendation was made last week, but the conditions have not yet been met. A new "spike peak" buy signal will be generated when VIX closes at least three points below the highest price reached from Oct. 1 onward. VIX moved higher earlier this week, due to the "election bump," so that highest point thus far is 23.14 on Oct. 8.
If VIX closes at least three points below that highest price, then Buy 1 SPY (Nov. 15) at-the-money call and Sell 1 SPY (Nov. 15) call with a striking price 17 points higher.
At this time, that highest VIX price is 23.14, so the buy signal would occur if VIX closes at or below 20.14. But there is always the possibility that VIX could register a higher price before reaching a peak, so adjust the numbers accordingly. NOTE: If there is not a striking price exactly 17 points higher, then use the next lowest existing one.
New recommendation: Clorox $(CLX)$ puts
A new weighted put-call ratio sell signal in CLX $(CLX.UK)$ has been confirmed by the fact that CLX has broken support at $161.
Buy 2 CLX (Nov. 15) 160 puts in line with the market.
New Recommendation: Walgreens Boots Alliance $(WBA)$
This a longer-term potential buy signal from Walgreens Boots Alliance $(WBA.AU)$. We are keeping this recommendation open but will not continue to reprint the reasoning behind the trade, other than to say that stocks that have been removed from the Dow Jones Industrial Average DJIA usually experience a strong rally within a matter of weeks after that removal.
We are retaining the same entry price as last week, but using the Oct. 25 expiration now: If WBA closes above $9.80, then buy 2 WBA (Oct. 25) 9.5 calls, in line with the market.
Follow-up action:
All stops are mental closing stops unless otherwise noted.
We are using a standard rolling procedure for our SPY spreads: In any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll up in the case of a call bull spread or roll down in the case of a bear put spread. Stay in the same expiration and keep the distance between the strikes the same unless otherwise instructed.
Long 1 expiring SPY SPY (Oct. 11) 550 put: This position is based on the trend of VIX sell signal and would be stopped out if VIX closes below its 200-day MA for two consecutive days. Replace this expiring put by buying 1 SPY (Nov. 1) 560 put.
Long 1 SPY (Oct. 18) 573 call and short 1 SPY (Oct. 18) 590 call: This spread was bought at the close of trading on Aug. 15, when NYSE new highs numbered more than 100 for the second consecutive day. It would be stopped out if, on the NYSE, new lows outnumber new highs for two consecutive days. The spread was rolled up when SPY traded at 573.
Long 1 SPY (Oct. 18) 570 call and long 1 SPY (Oct. 18) 549 put: This was initially a long straddle, intended to capture a large move in either direction. The puts were rolled down 10 points on Sept. 5, when SPY traded at 549. The calls were rolled up on Sept. 19. Now, roll the long call up and out to the SPY (Nov. 1) 577 call. Continue to roll the call up every time it becomes 10 points in-the-money.
Long 2 AOS (Oct. 18) 90 calls: We will hold these calls as long as the weighted put-call ratio for AOS $(AOS)$ remains on a buy signal.
Long 10 WEAT (Oct. 18) 5 calls: These were bought because of the put-call ratio buy signal in wheat futures. We will continue to hold WEAT WEAT as long as this buy signal is in effect.
Long 6 APA (Oct. 18) 25 calls: This is an MVB buy signal. Sell the calls if APA $(APA)$ trades at $28 at any time. Stop out if APA closes below $23. Note, both of these prices have been lowered, since the bands are falling.
Long 2 ABNB (Oct. 18) 130 calls: Raise the closing stop: Stop yourself out if ABNB $(ABNB)$ closes below $125.50.
Long 1 SPY (Oct. 25) 573 call and short 1 SPY (Oct. 25) 590 call: Sell this spread if SPX closes below 5,670 for two consecutive days.
Long 2 PLD (Nov. 15) 125 puts: We will continue to hold these puts as long as the put-call ratio remains on a sell signal. If PLD $(PLD)$ trades at $115 or lower, roll down to the PLD (Nov. 15) 115 puts.
Long 4 LX (Nov. 15) 2.5 calls: Stop out on a close below $2.85 for LX $(LX)$.
All stops are mental closing stops unless otherwise noted.
Send questions to: lmcmillan@optionstrategist.com.
(MORE TO FOLLOW) Dow Jones Newswires
October 10, 2024 07:15 ET (11:15 GMT)
MW How the presidential election is playing havoc -2-
Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager and is the author of Options As A Strategic Investment. www.optionstrategist.com
(c)McMillan Analysis Corporation is registered with the SEC as an investment advisor and with the CFTC as a commodity trading advisor. The information in this newsletter has been carefully compiled from sources believed to be reliable, but accuracy and completeness are not guaranteed. The officers or directors of McMillan Analysis Corporation, or accounts managed by such persons may have positions in the securities recommended in the advisory.
-Lawrence G. McMillan
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October 10, 2024 07:15 ET (11:15 GMT)
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