Elevated VIX/VXV Ratio "Retest" 12-7-18 -- Another Test Suggesting Short to Intermediate Term Rebound of 1 Week or More

I create a condition scan today looking at times of persistent elevated VIX/VXV ratios, followed by a "retest" of the ratio to a lower high.

Scan Criteria
10 day avg.VIX:VXV ratio peaked at >1.0 over the last 2 months
Today VIX:VXV single day ratio is >1.0
Today the 10 day avg. ratio is LESS THAN 1.0

The VXV only goes back 11 years, but includes almost all of the last bear market and several major corrections since then.

There was a notable forward positive skew especially at 4-5 days ahead.

Adding the condition of a large down day in SPY or a large 3 day maximum decline, made the skew stronger.  Those conditions fit our current environment.

This scan condition has been excellent as an opportunity to sell puts/premium or write an
ATM or OTM bull put credit spread with 1 week until expiration.

Some Stats For Current Market Action

This morning I looked at several combinations of factors in the current market compared to past market data.  I will provide a few close estimates here and give an idea for a profitable course of action.

There is about 40% chance of today's gap down filling today
There is about 60% chance of today closing above the open

Given today's gap down in SPY of about 1.6% I look at what happened if SPY closes down more than 1%

Scan Criteria
Yesterday closed down 2% or more
Today gapped down 1% or more
Today closed down 1% or more

When I ran this scan, I got 19 instances back in the past 23 years.  All of them showed basically 100% loss of premium if selling an ATM put at the close with 5 days until expiration. 

So the market on average rallied significantly, and with elevated volatility it was a good time to sell options versus buying options.

Trade Idea
If today closes down (especially if 1% or more), a bull put credit spread with ATM strikes could be written with an expiration of next Friday.

Also, cycles I use are suggesting upside into mid December or longer.  And in the above scan, there was a very strong expected value by holding for 8-10 days from the close of the signal day

So a Dec 24th SPY expiration could be used as well for an ATM bull put credit spread

Several Conditions Suggesting A Probable Rebound Coming In Stocks Over 1-2 Weeks or More

I spent considerable time testing current market conditions against past data, and while it does not appear to be a screaming bottom, there are several factors which I rate to be significant that produce some very strong short skew results to the upside.

Some of the condition combinations below produced significant upside skews over the coming 1-2 weeks.

VIX up 20%+
Equity P/C ratio 21/84 avg. >= 1.05

VIX up 20%+
VIX/VXV >= 0.95
VIX/VXV 10 avg. >0.95

Total P/C 5avg. < -1 st. dev
SPY down >= -1%

Based on the large increase in the VIX yesterday as well as an extended period of VIX/VXV elevation one of the more highly probable plays here would be writing an OTM bull put credit spread with 1 to 2 weeks until expiration.

I am looking at spreads that are ATM or about 1% OTM.

VIX/VXV Ratio Study Suggesting a Rebound Into Next Week 10-18-18

The VXV (3 month volatility index) does not have a real long history, but has data going back about 8 years or so.

Today the VIX/VXV ratio closed a bit above 1.0 which is a theoretical imbalance in the ratio as the VIX is shorter duration and typically has lower volatility.

I ran a scan to look at the following:

• VIX/VXV > 1.0
• SPY closes down 1% or more
• Price is NOT at a 10 day low

So the idea here is that the volatility remains elevated with a sizable sell off, but price is NOT breaking to lower lows.  I wondered whether price being above recent lows had any difference in the past compared to price falling to new lows.

The data suggests a significant positive skew in the next week price action for the scan noted above.  

Compared to price making a new 10 day low on the day, our current conditions had both higher closing price action moving forward as well as a larger positive skew in MAX GAIN to MAX LOSS over coming days.

There was no positive skew in MAX GAIN to MAX LOSS over the next week when price was declining to a 10 day low with the other conditions listed above.

So in the scan above, 23 instances were returned, and in 20 of them, my option price model shows that the ATM put lost over 90% of its value by expiration 5 days forward.

This data suggests that currently there is an opportunity to sell premium or write a bull put spread with expiries either next Wednesday or next Friday as the data on both would be about the same.

I did write a credit spread near the close today with expiry of next Friday.

Pete

Stock Market Volatility - Big Pop or Big Drop Ahead? 10-11-18

I have spent considerable time today comparing current market conditions with past data in order to guide expectation and strategies for trading.

MOST of the extremes in VIX, put/call ratios, multiple gaps downs and back to back down days or down streaks have in the past led to strong short term rebounds with peak gains coming at 4-8 days later.  So I think it is possible and reasonably probable that stocks rally 2-6% over the next couple weeks on a closing basis from today's low.

However, and few of the conditions I looked at which indicate very extreme readings, like 3+ standard deviation from the norm, suggest there is also a real possibility of a short term "wipeout" move which will occur before any rally attempt materializes.

Currently, I would estimate the probability of a 5% or greater decline, over the next 3 days or less, to be around 40%.

There is currently no bullish divergence on the hourly MACD chart of SPY, and given the strength of the decline, I would expect for that to develop before the low is in. 

If there is a gap down tomorrow, then from past similar instances I would estimate that from tomorrow's open there is a 2:1 or greater MAX gain versus MAX loss after the open, with a high probability of a close above the open. 

This data is useful in particular for a Friday where if tomorrow gaps down, we could write an option credit spread ATM or slightly OTM with the expiration at tomorrow's weekly option.

Since volatility is very high, and the odds of a close above the open are well above 50% from past stats (more like 75% from what I am looking at), then this could be a nice time to SELL premium with the limited risk of a bull put credit spread.

I may update tomorrow.


Pete