Equity index traders who have been saying for the past year that they wanted volatility have had their wishes granted over the past two weeks. Last week, the VIX volatility index hit a multi-year high, and the S&P 500’s implied volatility surged to levels last seen when Lehman Brothers failed in 2008.
Trading volume has also picked up in the index futures, ETFs, and individual stock, leaving the equity volume last week at its highest since August 2011 when Standard & Poor’s stripped the U.S. of its triple-A credit rating during the debt-ceiling crisis.
We have also been watching the money flow in recent weeks. Last week, the market saw a record $25 billion withdraw from mutual funds, which is likely part of the reason that so many market-on-close (MOC) imbalances were very strong to sell.
On Friday, the S&P 500 futures saw another brutal sell-off after the futures dropped 88.25 handles from the high of day down to Tuesday’s overnight session low in a matter of less than four hours. However, what happened next was a 107.50 handle rally into the close, giving an indication the selling could be over after the double bottom and the MOC finally seeing an inflow of over $2 billion on the weekly close.
We also refer to Marty (PitBull) Schwartz’s old rule, which says to look for a bottom on the Thursday or Friday the week before monthly expiration. That may be what we saw on Friday. According to the S&P 500 expiration week study that we use, the numbers for the February expiration are typically weak; but given the current market personality, these historical stats are less important.
Does this mean the sell-off is over? Not necessarily; but if the S&P 500 has found a bottom and is going to stage a rally, this week should see some major follow through. Traders that established positions based on a lack of volatility were hurt last week and the unwinding of those positions could take into this week. My view is that you can still play both sides of this market, selling the rallies and buying the pullbacks; or, if you want to take the path of less resistance, you could just buy the pullbacks. We think it is possible that the ESH18 could head back towards the 2680-2700 area, and if it really gets going, maybe a little higher.