MorningWord 6/23/14: The World is Full Of Crashing Bores – $SPY

by Dan June 23, 2014 9:31 am • Commentary

Traders love stats, and and it seems like the whole world keeps repeating the following 2 statistics supposedly indicating some sort of impending market correction right around the corner:

First, it’s now been 45 days (as of Friday’s close) in which the S&P 500 has not closed up or down 1%, the longest period since 1995.

Second, the fact that the S&P 500 has not had a 10% correction in more than two years.

After the S&P500 gained last year of 30%, and is up 6% so far this year, and the way people talk about the current leg of the rally, you would think that the higher we go the higher the cost of portfolio protection would be. But the opposite is true. The VIX is nearing all time lows and SPX 30 day at the money implied vol (the price of options) is 8!  And because the S&P 500 has not had a 1% up or down close in more than 45 trading days, 30 day realized vol (how much the index has moved in that time period) is at 7!

To demonstrate just how cheap S&P 500 options are, using the SPY ($196) and buying the SPY September straddle (the 196 call plus the 196 put) costs about $8.60. So to break-even on Sept expiration you would need a move to $204.60 on the upside or $187.40 on the downside or about 4.4% in either direction.  And that’s in September.

When you consider the lack of current movement, and the stretch without a 10% decline, it does seem that something has to give. That doesn’t necessarily mean a correction and could mean a melt up. Traders love nice round numbers and the SPX is only 38 points away from 2000, (about 2% away) and in the other direction, 1900 (which corresponds with the prior breakout and the 50 day moving average, purple line below) is only about 3% away.

If a move to the downside did come, the one year chart below shows the level that seems more likely than not (but who knows when.) If the 50 day moving average were finally violated, a re-tracement back to the 200 day moving average (yellow line below circled in green) that also corresponds with the prior low from mid April seems likely. Since it’s been so long since the SPX has even touched its 200 day moving average (last time was Nov 2012) it seems crazy to even talk about the scenario.  But a move to that level represents only a 7% decline from current levels, which in normal bull markets seems to happen all the time. But in the current leg of this bull market, 7% would basically represent the largest peak to trough decline in the SPX in the last couple of years.

SPY 1yr chart from Bloomberg
SPY 1yr chart from Bloomberg