Last night I got back from a vacation that I left for on August 21st. It figures that the stock market crashed in between. While crash may be a bit extreme, in comparison to the lack of volatility we’ve seen in U.S. stock since Q3 2011, I think crash is about right.
Although I was overseas, I’ve been keeping a close eye on the quality of the bounce late last week and the severity of the sell-off this week. In this space on Aug 28th (Home on the New Range) we discussed how the volatility bands are now widened in the S&P500 (SPX), nearly double that of the range from February to early August:
The selloff means we now have another range to trade against. Just as we did from February to last week,only this time the volatility bands are massively wider. Prior support now becomes technical resistance at 2050 (red line) and the prior low of 1865ish should be I spot to shoot for on the downside. If it goes through there all bets are off:
We’ve just experienced a long period of low volatility in US equities that ignored pick ups in volatility in almost every other asset class around the world. The pick up in volatility means cheers for this rally from the lows could quickly turn to jeers.
The bounce in the SPX late last week felt like a knee-jerk reaction off of a very near term oversold panic condition. But this week’s reversal, specifically yesterday’s near 3% decline, felt a lot worse than the late last week’s bounce felt good. My main quote screen shows the nastiness in color yesterday, no stocks or sectors were spared, and few showed any sort of relative strength:
In volatile times, openings like today (futures up 1% as I write) tend be sold barring any positive macro news during the first hour. And for the time being, unless we see some indication that the Chinese economy is stabilizing, or that ours is accelerating, I suspect the path of least resistance for stocks remains lower.
This morning I got a text from a friend who asked if this was a good time to put some cash in U.S. stocks as she had some rolling out of a CD. My response was simple, if it were me, I would start averaging into large cap U.S. index funds. With the SPX down 10% from its all time highs, I might consider putting 20% of that cash in stocks. But certainly not all. If the market goes down another 10, 20, or 30% over the coming months / quarters you average in until all the cash (the portion meant for equities) in invested. I think it pays to be patient here. U.S. stocks will not be making a new high anytime soon. The situation in China will not turn on a dime and the Fed seems damned if they do, damned if they don’t in raising rates at their Sept 17th meeting. (this will cause more market volatility).
I have no idea whether the 10% correction (some call it a crash) in the SPX is close to the end. I do think we re-test last week’s lows soon, and possibly the October lows after that. But my main take-way is that the widening of the volatility bands will create some very attractive trading opportunities. Not just buying fear like last Monday, and selling near term over-exuberance like last Friday, but also looking for opportunities to use options to add protection, yield or leverage to existing holdings.
For instance, for Apple (AAPL) holders who would be willing to add on dips but think the stock now has a ton of overhead resistance, the recent vol spike, and the upcoming Sept 9th iPhone event could provide an epic opportunity to sell vol against your position (to add yield and a little protection). Selling an out of the money call and put (a strangle) against long stock could add a buffer to the downside, a limit buy order below the market, a limit sell order above the market while adding yield. With 30 day at the money implied volatility headed back towards last weeks multi-year high, it likely has only one way to go following the event regardless of the very near term direction of the stock:
Main point here is that use this new range to trade against your most convicted holdings, you have options (pun intended) in uncertain times.