The bear is gearing up for another attack, which could happen as early as this week.
Let me explain…
Almost two weeks ago, I showed you the monthly chart of the S&P 500.
The index had bounced all the way back up to its 20-month exponential moving average (EMA) line – the dividing line between bull and bear markets.
And I suggested that if the bear was still in charge, then stocks would be lower in the months ahead.
The market pressed higher anyway…
Then, last week, I showed you a chart of the bullish percent index for the S&P 500 (BPSPX).
It had just turned lower from an overbought condition, thereby generating a sell signal. And I suggested stocks would be lower in the weeks ahead.
Again, the market pressed higher anyway…
The S&P 500 is up 124 points (roughly 3%) so far this month. It was up 110 points last week. So, it looks like the long-term and intermediate-term bearish signals are having a tough time of it.
But remember, both of those signals tend to play out over weeks and months. So, we have to allow some “wiggle room” in the short term.
Today, though, we’re getting a bearish signal from one of our most accurate short-term indicators – our “crystal ball.”
Regular readers know we often look to Volatility Index (VIX) option prices for clues to the short-term direction of the stock market.
Whenever the price of VIX calls is much higher than the equivalent puts, the market is anticipating a higher VIX in the days ahead. And a higher VIX usually goes along with a lower stock market.
Whenever VIX puts are trading for a much higher premium than the equivalent calls, the market is looking for a lower VIX. And, a lower VIX often occurs with a higher stock market.
The trading signals from VIX options are so consistent and so reliable, that I refer to this indicator as a “crystal ball.”
Well, the crystal ball is now bearish for the short term.
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On Friday, the VIX traded at 19.30. The VIX August 17 $20 call options – which were $0.70 out of the money – were offered at $1.00. Meanwhile, the VIX August 17 $20 puts – which were $0.70 in the money – were offered for $0.30.
In other words, traders were willing to pay more than 200% more for a VIX call option that was $0.70 out of the money than for a VIX put option that was $0.70 in the money. This tells us that traders who are making bets on the VIX expect the index to move higher over the next few days.
This sentiment is even more evident if you go out a little further and compare the VIX August 25 $20 calls to the VIX August 25 $20 puts. The calls traded Friday offered at $2.50, while the puts were only $0.25. (I use my trading quote system to track these prices, but you can find them at FreeRealTime.com.)
VIX calls are far more expensive than the equivalent VIX put options.
So, VIX option traders clearly expect the index to move sharply higher between now and the end of August. And a rising VIX (rising volatility) usually accompanies a falling stock market.
So, if you’re making bullish bets right now, be careful. We have bearish signals from long-term, intermediate-term, and short-term indicators.
That doesn’t mean the market can’t press even higher from here. Heck, anything can happen…
But it does suggest the risk/reward potential in the stock market now favors the bear.
Best regards and good trading,
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Jeff Clark
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