Buy-The-Dippers Return

Last week's short pullback began the Friday before when the S&P 500 Index closed below support at the 50-day Moving Average. Then the gap open lower last Monday on the Evergrande news confirmed the start of a new pullback. However, by Wednesday "buy-the-dippers" prevailed, carefully ending the decline. By the end of a week full of fundamental news, the S&P 500 Index managed to eke out a small gain. The Market Review contains more details including a long call spread idea for the Energy Select Sector SPDR Fund (XLF).

S&P 500 Index (SPX) 4455.48 added 22.49 points or +.51% last week after declining 75.26 points on Monday before recovering Wednesday. Now just back above the key 50-day Moving Average at 4439.43, it could hesitate until the end of the week waiting as the much-ballyhooed weak September draws to a close.

Invesco QQQ Trust (QQQ) 373.33 declined .09 points or -.02% last week and like the SPX opened gap lower on Monday then recovered Wednesday. On Monday's decline, cautious traders may have started to hedge long positions. However, by Thursday as it closed back above the 50-Day Moving average, now at 370.03, hedges seemed unnecessary as option and futures indicators (see below) confirmed the upturn on Friday. In addition, Thursday's advance closed the gap created at the open on Monday. While it may hesitate until the end of the week, it appears the short-lived pullback ended last Wednesday.

CBOE Volatility Index® (VIX) declined 3.06 points or -14.70% last week ending at 17.75. Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, declined 2.05 points or -13.59% to close at 13.04% compared to 15.09% for the week ending September 17.

Our estimate of the mean for the current relevant range that begins on June 5, 2020, at 19.70% and slopes downward, ended Friday at 14.91%, slightly above Friday's close.

VIX Futures Premium

VIX futures premium on Friday ended back in the middle of the bullish green zone at 15.22%, up from -4.59% last Monday, turning positive again last Wednesday.

Since most of the volume and open interest are in the two closest futures contracts measuring the volume-weighted premium relative to the standard 30-day VIX provides a good real-time sentiment indicator based upon actual commitments of large Asset Managers and Leveraged Funds. The chart reflects the distance from the VIX to the futures curve computed from the two front-month contracts.

VIX-VXST Spread

While the VIX Index is calculated using monthly options with 30-days to expiration, VXST uses options with 9-days to expiration and include options that expire in one week making thn more sensitive to changes in short-term implied volatility. This spread measures the distance from the 30-day VIX to the 9-day VIX to produce an indicator.

Typically, the spread is positive with the VIX higher than the VXST. Caution signals begin flashing when it turns negative as short-term implied volatility increases faster than the standard 30-day measure. Consider it like an option sentiment indicator usually displayed as it begins turning negative. However, it can also be useful to measure the degree of bullishness or hedging complacency.

On Friday, the spread ended at 2.51 up from -1.99 on Monday.

Market Breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that considers the number of issues traded, and reported by McClellan Financial Publications. Although it turned slightly positive last Thursday for the week it declined 76.65 points to end at -60.90 and below the low made last September 30 at -8.12 before it turned higher on October 1, 2020 (left side of the chart) then declined once again in mid-October. With October 1, four trading days away it will likely start a slow upturn and then accelerate in the first part of October.

Consider it like setting the stage for a play on Broadway, perhaps it will be delightful feel-good musical as it pivots and turns up or a tragedy as it continues lower. Based on the seasonal pattern a delightful feel-good musical seems more likely.

WTI Crude Oil (CL) 73.98 basis November futures ended the week up 2.16 points or +3% higher breaking out to close above the July 6 intraday high at 73.58.

Energy Select Sector SPDR Fund (XLE) 50.90 up 2.17 points or + 4.46% last week breaking out to close above the August 2 high at 50.01 setting off a Head & Shoulders Bottom pattern.

With a measuring objective back at the June highs above 55, consider this long call spread using November 19 calls with 53 days to expiration.

With a current Historical Volatility of 32.52 and 21.91 using the Parkinson's range method, the Implied Volatility Index Mean is 29.42 at .09 of the 52-week range. The implied volatility/historical volatility ratio using the range method is 1.34 so option prices are moderate relative to the recent movement of the ETF.

Friday’s option volume was 246,904 contracts with the 5-day average of 167,940 with reasonable bid/ask spreads.

Using the ask price for the buy and mid for the sell the call spread debit on Friday was 1.03, and 34% of the distance between the strike prices. Use a close back below 49 as the SU (stop/unwind).

The spread above is based on the ask price for the buy and middle price for the sell presuming some price improvement is possible. Monday’s option prices will be somewhat different due to the time decay over the weekend and any underlying price change.

Strategy

In bull markets, a good strategy is to stay long equities and/or ETFs and then tactically hedge pullbacks as they begin developing since ordinary pullbacks can become corrections when something unexpected happens. Then corrections can become downturns when something else unexpected happens, and downturns can become bear markets when many unexpected things change medium and long-term fundamentals.

Implementing hedging strategies after last Monday's decline showed losses by Wednesday. Based upon improving indicators as September ends any remaining hedges are unlikely unnecessary. Consider any losses as insurance cost against a further possible decline caused by potential Evergande contagion.

Summary

Last week's pullback set off by Monday's gap open lower ended on Wednesday as "buy-the-dippers" returned after concluding Evergrande's problems were not likely to spread and cause widespread contagion in the financial sector. With the S&P 500 Index back above the 50-day Moving average and September drawing to a close, odds favor the long-term uptrend resuming soon.