The Volatility Index (VIX) just sent a warning to short-term traders.
Over the past two weeks, the S&P 500 has been cruising to one new high after another. The index has closed higher for 11 of the last 12 trading days.
Meanwhile, the VIX has been falling.
That’s not a surprise. Indeed, that’s what is supposed to happen. Stocks go up while volatility falls – thereby confirming the rally in stocks.
But, a funny thing happened on Wednesday afternoon…
The Volatility Index Rallied
At 1:45pm ET, just as Fed Chairman Jerome Powell took the stage at the New York Times DealBook conference, the S&P 500 was trading at 6065 – up 15 points for the day. The VIX was at 13.15 – down 1% on the session.
Once it became obvious the Fed Chairman was not going to say anything hawkish about the direction of interest rates, traders started buying stocks. The S&P 500 gained another 22 points during the final two hours of the session.
The index closed at its highest point – ever.
Oddly though, the Volatility Index rallied in the final two hours as well. The VIX reversed the day’s losses, pressed into positive territory, and finished the day at 13.45 – up 1.13%.
Of course, we don’t want to read too much into the action of just one indicator during a two-hour window. But, when the VIX rallies along with stock prices, it is often a warning sign that the rally will soon reverse.
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It’s also concerning that VIX call options are trading for about 10x the price of the equivalent put options. We’ve seen how this condition usually leads to a short-term rally in the VIX.
And, a rising VIX usually goes along with a falling stock market.
None of this means that the stock market can’t press higher in the weeks to come, or that the widely anticipated “Santa Claus rally” won’t happen this year.
Wednesday’s action in the VIX, though, does suggest the stock market is headed for some short-term weakness. And, the Santa Claus rally will likely start from a lower level.
Traders should brace for at least a short-term pullback.
Best regards and good trading,
Jeff Clark
Editor, Market Minute