By Jeff Clark, editor, Market Minute
It’s almost as if nobody was bearish last week.
At least, nobody seems willing to admit that today. Just about everybody seems stark, raving bullish – which is a sharp contrast to the conditions last Friday.
You remember last Friday, don’t you?
The stock market was in the throes of the sharpest selloff in several months – sparked, in part, by the Federal Open Market Committee (FOMC) announcing it might be willing to maybe start talking about the possibility of taking its foot off the economic accelerator… in about two years from now.
That, plus the potential for seasonal weakness that tends to hit the stock market this time of year, had most traders rushing over to the bearish side of camp.
We were skeptical…
On Monday, I pointed out that several technical indicators were already in oversold condition.
So, there wasn’t much energy left to fuel a big decline. Investor sentiment (including the financial TV talking heads), a contrary indicator, had shifted from bullish to bearish.
And, Volatility Index (VIX) option prices were not predicting a rise in volatility. So, the odds of a significant decline this week seemed low.
The S&P 500 opened Thursday morning about 100 points above where it finished last week. The index closed on Wednesday at a new all-time high. And, what a difference this week has made…
The technical indicators aren’t oversold anymore… Investor sentiment is downright bullish… Financial TV talking heads aren’t yammering about the “seasonal weakness” anymore. Instead, they’re talking about how July is normally a strong month for the stock market.
Perhaps the biggest change, though, is in the VIX option prices – where call options are now considerably more expensive than the equivalent puts.
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For example, when the VIX traded yesterday at 15.80 – its lowest level of the year – the VIX June 30 $16 calls, which expire next Wednesday, were trading for $1.70. Meanwhile, the VIX June 30 $16 puts were just $0.10.
In other words, traders were willing to pay 17 times more to buy VIX call options than VIX put options.
If we go out to mid-July, the difference is just as extreme. The VIX July 21 $16 calls were trading for $2.80, while the equivalent puts were $0.70.
Clearly, VIX option traders are betting on an increase in the VIX over the next few days, and the next few weeks. And, a rising VIX usually goes along with a falling stock market.
Of course, there’s no guarantee we’ll get a stock market decline over the next several days.
But, in the past, we’ve used VIX option prices quite often to gauge the short-term direction of the market. This indicator has been right far more often than not – that’s why I refer to it as the “crystal ball.”
Last week, the crystal ball went against popular opinion and suggested the stock market was more likely to rally than fall this week.
Now, the crystal ball is suggesting we may get the decline that nobody is looking for anymore.
Best regards and good trading,
Jeff Clark
P.S. Every week my colleague Eoin Treacy shares his thoughts on what’s going on in the market.
Last week, he covered the highly anticipated Fed meeting last Wednesday, the future of the dollar, and the recent dip in gold. And now, click below to hear what Eoin has on his mind for this week.
Eoin’s Insights
Happy Friday Market Minute readers. As usual, I have another installment of my weekly video series where I give my thoughts on what I currently see happening in the markets.
Today, I’ll be going over the new infrastructure bill, the action in Tesla, and supply chain improvements in the semiconductor sector. Just click below to watch.
Reader Mailbag
Do you agree with Jeff’s “crystal ball” that there’s going to be a decline? What do you think changed over the course of a week?
Let us know your thoughts – and any questions you have – at [email protected].