Wall Street Elite
A VIXtorious Options Trade
There's much to be said about sentiment readings, although, as we mentioned last week, they can be notoriously difficult to employ successfully. It's just too dang hard to quantify what's an 'extreme' reading for most of them. And it's only the extreme readings that we're concerned with.
That said, last week something interesting occurred that we don't see very often. A bevy of sentiment indicators lined up together in the overly-bullish column, producing what we feel is an event worth noting. Here's the way it came down:
· AAII's individual investor poll flashed six year high readings,
· Mutual Fund Manager percentage cash levels struck their lowest readings ever (i.e., these guys are all in),
· Hedge Funds recorded their most bullish sentiment levels ever, according to a Bank of America/Merrill Lynch survey,
· Futures traders are feeling more bullish than at any time in the last four years, according to a poll taken at futures.com
· Economists, according to news-org polls are unanimously bullish, and
· Newsletter advisories are offering their highest bullish readings in seven years.
We'll leave you to do the math, but it does look a tad worrisome, given that we haven't seen a breakout in the major averages to new highs yet, and that when we do, these number should only surge to even hotter and higher supercharged, atomic bullish levels. And what to do then?
Given the foregoing, our position is the same as we outlined in last week's letter. Unless and until we see new highs on the three major equity indexes, we remain committed to our bearish stance, and we're holding on to our SPX PUTS.
Technical Tangoes with Begrudging Barometers
Inexact sentiment indicators come in a variety of forms. The volatility gauges, for example, VIX, VXN and QQV, can also be used by traders at extreme levels as contrarian indicators. But this, too, is not an easy business.
Performing technical analysis on the VIX is more a rogue's game than honest trade, in our opinion, though there are some who swear by it. For our part, the facts inveigh against traditional charting of volatility indexes. For one, these indicators are derivative phenomena in the truest sense – they gives readings as a function of option prices, which are, in turn again, a function of the price of an underlying index, in the case of the VIX, the S&P 500. We say that makes it just a couple of steps too far removed from actual buyers and sellers to be used as an object of charting.
It's also plainly not a security. The bars or candles you see on a VIX 'price chart' do not represent anything that even approximates the chart of, say, Exxon Mobil – or any other stock for that matter.
And that means that any and all attempts to draw trendlines or apprehend 'breakouts' or analyze Relative Strength numbers or Stochastics, etc. have to be taken with a grain of salt.
But does that make the VIX chart useless?
Not at all. It's just the raw data, rather, that gives us the information we can genuinely use. That is, the level of volatility itself can be a clue to overbought/oversold levels, and, as Matt McAbby, our weekly Bourbon & Bayonets analyst, points out, the daily 'compression' reading on the VIX, i.e. the absolute movement on any given day's trade, can also assist forecasting efforts.
Let's look at the VIX for the last half-year:
After March's spike to highs over 30, the VIX has settled down to levels last seen just prior to the late-February index highs. Again, since that time we've seen no new highs, but the general level of bullishness has increased along with last Friday's plunge in volatility.
We're not Impressed
Far from seeing happy days in all of this, we tend toward a greater pessimism. And we believe we have support from the bond market, where it appears a bullish breakout may now be in the works for the long bond. Not a joke. A bullish breakout. Look here:
The technicals on TLT, the iShares Barclays 20+ Year Treasury Bond Fund, show a reverse head and shoulders bottom in the making, a bullish development that runs counter to all current conventional thinking about U.S. Treasury Bonds, but that fits hand-in-glove with the macro picture we see unfolding in markets over the next couple of months.
That is, an equity selloff and concomitant 'flight to quality' in the Treasuries.
You Know it Don't Come Easy
If and when it does transpire, we expect a battle royale in the bond pits. Major resistance from the long term moving average (in yellow, above) and the neckline that marks the breakout point for the head and shoulders bottom (in red, above) meet at exactly the same point.
If it comes down to it, two opposing technical outlooks will then be forced to duel over the near term direction of the bond market, and the winner should see outsized gains in fairly short order. We'll be watching closely for possible trades as the situation clarifies itself over the coming weeks.
In the meantime, our hunch is to bet against the crowd. We expect a decidedly bullish move in the mid- to long-end of the curve is on its way.
Trading a Tool for Profit
This week, we're recommending readers buy what we feel is now the cheapest security available, given the market's current makeup.
With the VIX literally toying with 52 week lows and investor sentiment at multi-year highs, and with the bond market pricing in a possible defensive outlook on the part of global investors, and all of this in the face of a Quantitative Easing regimen that looks not to be continued beyond June, we say volatility is about to go gangbusters and what you're seeing now is just the calm before the storm.
The trade is a simple one. Buy VIX CALLS.
The June 17 strike now trades with a spread of $4.50-$4.70. Any pullback in equities should see the VIX move into the mid-20's, at least. Even a bullish breakout – if swift – could engender a similar response.
Wall Street Elite recommends immediate purchase of the VIX June 17 CALLS, now trading at roughly $4.50.
With kind regards,
Hugh L. O'Haynew,
Analyst, Oakshire Financial
