You can attribute the 6%, 5 day rally in the S&P 500 (SPX) to whatever you like. The negative sentiment might have gotten a tad off-sides leading up to the end of the quarter. But the price action of the last few trading days feels like the pendulum might have shifted too far, too fast the other way. To me, the jury is still out whether we just shifted gears back into a bull market, six weeks after the largest volatility shock in years.
Taking a quick look at the year to date chart of the SPX, there is an identifiable trading range between the August 24th low at 1867, and about 2000. On Sept 17th, the SPX opened above 2000 and closed below that level, marking the start of a 7.5% peak to trough decline until the recent lows:
For those nimble short term traders, you have the levels to trade against, with 2050 now serving as massive technical resistance.
The SPX is now only down 3.5% on the year and down a little less than 7% from the all time highs made in May. For those that still believe there is a Fed put in the market, then this rally makes sense. And to bolster that case, this next chart shows how the SPX testing the uptrend that has been in place from its 2009 lows, and has so far held:
Although, on a nearer term five year basis, the uptrend from the 2011 lows is broken. A failure at 2000 would once again mean a retest of the August lows is very likely.
The charts can be read either way. It really depends on your world view. It’s my belief that the framework that made the uptrend on historically low volatility possible since mid 2012 is no longer in place. And the recent break below 2000 is a meaningful technical change from years prior.
The multi-day bounce in equities has gained some serious steam while Chinese equity markets have been closed since Wednesday for their Golden Week Holiday. I think its important to note that Chinese stocks, as measured by the Shanghai Composite closed the quarter in a fairly precarious spot just above important support at 3000:[caption id="attachment_57411" align="aligncenter" width="600"] Shanghai Composite 1 year chart from Bloomberg[/caption]
If we continue to squeeze higher in the coming days (as we get closer to Shanghai’s reopening on Oct 8th) we could see a meaningful collapse in options prices (volatility) providing a nice opportunity for long premium directional trades. Thirty day at the money implied volatility in the SPY, which traded as low as 10% in July spiked to 32% on August 24th, a level in short dated SPY options not seen since the European Sovereign Debt crisis in 2011:[caption id="attachment_57412" align="aligncenter" width="600"] SPY 5 yr chart of 30 day at the money IV from Bloomberg[/caption]
IV is now back to 17% and if this rally continues for a couple more days we’ll see them even lower.
The main point here is that we don’t think the bull market is back on, we think that Chinese equity volatility is likely to continue and that the powers that be at the PBOC are not one and done with their currency devaluation. And that U.S. equity investors will soon realize that the Fed on hold is not bullish for stocks. But we want to be patient.
A massive equity rally into Q3 earnings season (starting next week in earnest) is a poor set up from a sentiment standpoint. If options prices continue to fall in front of Shanghai reopening, and in front of earnings we will look to slightly out of the money put spreads in the SPY.
For example, with the etf near $199, we would consider buying the the Nov 195 / 180 put spread for about $2.70. The hope for an entry would be the SPY above 200, and vol in a couple points. Stay tuned.