The S&P 500 moved above the resistance zone I have been watching at 4,200 to 4,225. No breakout is complete unless it is confirmed, and for that to happen, you don’t want to see the index slip back below 4,225. I have doubts about Friday’s rally for several reasons, but the biggest reason is the volatility crush that sent the index higher, as the VIX tagged its lowest in nearly two years.

You just have to wonder, though, how much more downside is left in the VIX at this point, with most of the gamma now at higher levels and the most likely pain trade for the VIX index being higher.

Meanwhile, we have seen the SKEW index rocket higher, and that is likely due to traders buying out-of-the-money volatility to protect their short volatility positions. This was seen a lot in 2021, as the Fed was pumping in tons of QE and acting as a market volatility damper. This same trade emerged in mid-March, as the Fed allowed its balance sheet to expand by giving banks loans and increasing reserve balance.

The debt ceiling limit allowed reserve balances to stay elevated, which allowed this trade to continue. But now, the TGA will start to be refilled this week. If the money in the reverse repo facility stays unchanged, reserve balances are going to start to drop quickly, and that liquidity that has helped dampen volatility is going to be over with, which could result in a further unwind of this trade.

For some reason, this period of time reminds me of January 2018, when we saw a massive blow-off top on the indexes and a very sharp drawdown. On Jan. 29, 2018, I wrote a story that noted the 4 signs the stock market was ready to fall. I noted that the S&P 500, Microsoft, Amazon, and Alphabet had all seen their stocks advance dramatically, and RSIs were well over 80.

Today is not dissimilar; while the RSIs aren’t as high, their stocks and index trade with RSIs well over 70 and hitting their upper Bollinger bands on the daily and weekly charts. The NDX has been trading above its upper Bollinger band on the weekly chart for two weeks, and it has an RSI of over 70.

Apple (AAPL) is trading over its upper Bollinger Band on the daily chart with an RSI over 70.

Amazon (AMZN) is trading at its upper Bollinger band with an RSI over 70.

Meta (META) is trading at its upper Bollinger band with an RSI of over 80.

Tesla (TSLA) is trading at its upper Bollinger band with an RSI above 70.

The XLK is trading at its upper Bollinger band and with an RSI over 70.

Sure, these are conditions, and conditions can grow even more over-bought. But these aren’t the type of conditions that one generally wants to see when the market is trying to advance after a long consolidation on the S&P 500, especially when it comes from the biggest stocks in the index. Because it means a lot of energy and buying power has already been spent.

Additionally, there has been a big grab for calls in this market, and that is most noticeable in how the IV for calls on the S&P 500 holds up much better than the IV for puts when looking at the SKEW for the S&P 500 across strike prices for the June OPEX.

This market has become extremely overbought under the surface, and I am skeptical that the Friday rally can last.

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