The VIX Correlation saga continues again for the third week as the S&P 500 Index made two more new intraday highs along with a new closing high last Monday. For now, this could be the last look at the correlation as it turns negative again shown in the expanded chart below, followed by a mark-to-market report for last week's SPDR S&P 500 ETF long put spread idea.

S&P 500 Index (SPX) 3110.29 declined 10.17 points or -.33% last week after making a new closing high Monday. Now well above the upward sloping trendline from the June low and the 50-day Moving average at 3017.69, last week's modest pullback probably ended Friday. This expanded chart with the 10-day VIX correlation below shows it turning lower or becoming more inversely correlated Friday.

However, as an indicator over the last year, the record is less than encouraging. As it advanced well into positive territory in late April, it gave a good warning of the June SPX decline shown at the first blue vertical line near the middle of the chart. Then last week's irregular pattern as it again turned slightly positive, preceded last Wednesday's SPX decline, but quickly turned negative again. However, the orange vertical lines show at least three times in the last year when it failed to give any warning including last December. In conclusion, the 10-day VIX correlation indicator joins several others in the interesting, but an unreliable category. Now, it's back to the drawing board for some fine-tuning, since the concept of rising implied volatility preceding corrections and significant declines remains valid.

CBOE Volatility Index® (VIX) 12.34 gained .29 points or + 2.41% last week. 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, gained .38 points or + 3.89% to end the week at 10.16% vs. 9.78% for the week ending November 15. It looks as if it may have found the bottom of the recent range encouraging more VIX put option selling.

VIX Futures Premium

The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second-month futures contracts.

With 17 trading days until December expiration, the day-weighted premium between December and January allocated 85% to December and 15% to January for a 22.22% premium, still in bullish green zone, vs. 23.81% for the week ending January 15.

The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month futures contract converges with the VIX at expiration on Wednesday, December 18.

For daily updates, follow our end-of-day volume weighted premium version located about halfway down the home page in the Options Data Analysis section on our website.

Strategy

The overriding strategy consists of hedging long positions when pullback risk increases as determined by the indicators. Easily said, but harder to implement since there are many indicators and they often conflict. Some like relative strength, trendline lines and moving averages are quantifiable, while others like the latest statement from the Federal Reserve about interest rate policy or more quantitive easing or news of an eventual China trade agreement are obviously more difficult.

Currently, record-high equity prices reflect expectations for lower China tariffs since a trade deal seems right around the corner along with renewed worldwide monetary stimulus that will soon cause a dramatic advance in global PMIs.

This consensus view seems unchallenged by traditional short-sellers and disbelievers, and since everybody is thinking alike, the major indices trade in narrow ranges. For example, the historical volatility also called the realized volatility of the S&P 500 Index using the range computation method was 5.49% on Friday the lowest since September 28, 2018, at 5.36%, compared to the mean average of 10.25% since August 11, 2017. Think calm before the storm or regression to the mean, – but when and why?

Remember, "If everyone is thinking alike, then somebody isn't thinking" – General George S. Patton Jr.

Recent signs of rotation into "Risk Off" sectors like heath care and biotech suggests value-seeking since some cyclical sectors like industrials and materials are also improving, but energy remains a laggard.

Although futures and option indicators remain bullish, market breadth tells a slightly different story.

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, declined 111.41 points or -16.99% last week ending at 544.22 after closing below the important 50-day Moving Average last Tuesday. This most reliable leading indicator suggests caution.

SPY Put Spread Mark-to-Market

SPDR S&P 500 ETF (SPY) 310.96 down .83 or -.27 for the week

Last week's long put spread suggestion was booked last Monday at the close with the ask price for the long Jan 17 305 put at 3.91 and the mid-price for the short Jan 17 295 put at 2.21 for a debit of 1.70, at 17% of the width between the strike prices. On Friday the ask price for the short put was 2.30 with the mid-price of long put at 4.10 for a credit of 1.80. With a mark-to-market credit of .10 and 53 days to expiration, the SPY put spread insurance worked well, covering some portion of long equity risk as expected.

As long as market breadth continues declining maintaining this insurance put spread seems prudent. However, if the pullback ended Friday as suggested the VIX correlation indicator, the trade plan set the SU (stop/unwind) at 50% of the initial debit, or about .85 and since this would represent an insurance cost no longer required, the policy can be canceled by unwinding the spread.

Also, keep in mind, the potential for a "sell the news" event on any conclusive China trade agreement announcement, whenever it comes.

Summary

As anticipated, last week's S&P 500 Index pullback began and may have ended Friday, according to the VIX correlation indicator. Although the VIX futures and option indictors remain positive, diverging market breadth suggests a degree of caution still seems sensible, implemented by an out-of-the-money SPY put spread as portfolio insurance.