On the Central Bank front, the focus this week was on the ECB, and this morning the bank’s head Mario Draghi for all intents and purposes reiterated his multi-year long commitment to do “whatever it takes” to keep the pig that is the EU afloat. The Euro is getting smacked as one would expect, down 1.6% today. Whats interesting to me is that our equity markets have screamed on the news, despite what is likely to be a continued headwind to earnings of U.S. multinationals, Crude Oil has come off its earlier highs and very surprisingly, the yield on the 1o year U.S. Treasury is virtually unchanged just above 2%.
Which brings me to what will be the focus of central bank watchers next week, the FOMC’s Oct 28th meeting where the Fed Fund futures are placing a very low probability on the first rate increase in 9 years. I think it makes sense to look back at the price action in the S&P 500 leading up to the FOMC’s last meeting on Sept 17th where the market was far more uncertain as to the potential for a rate increase. The circle below shows the initial rally that existed following the Fed’s dovish commentary, but ultimately the reversal with the SPX closing that day on the low, and starting a sell off of 7.5% from that peak to its Sept 29th trough:
Well here we are again, very near the late August breakdown level, and above the Sept FOMC day highs. This time there is considerably less uncertainty about the Fed’s next move, but there has been little economic data both here and abroad that should have made the voting members feel too much better about their fears of weakening global growth and the potential adverse affects on our economy that was evident in their Sept commentary.
While there seems to be little worry in our equity markets, especially for those who look at spot VIX, now below its 200 day moving average of 16.50, at 15.20, I would suggest that possibly a better reading of investor fear is the inability for Treasury yields to rise in the face of recent Chinese selling, being offset to some degree from buying of U.S. investors. Per Bloomberg, China has sold $200 billion worth of Treasuries this year:
From my perch, the TLT (the iShares 20 year Treasury etf) should be getting slayed on a day like today, less than a week in front of an FOMC meeting that should be more hawkish than last month. Yet it looks like it is building steam for a breakout above near term technical resistance at $125, which is also just above its 200 day moving average at $124.50:
And, the day day realized volatility on the SPX has just bounced off of the levels it was at in mid August just prior to the market swoon:
As we look at the SPX at 2 month highs, nearing massive technical resistance in the index at 2050, eyeing next week’s Fed meeting, and the following week’s Oct jobs report on November 6th, it could make sense to consider what is becoming increasingly cheap short term protection.
The options market is implying about a 2.2% move in either direction in the SPY (the etf that tracks the SPX) between now and November 6th. That seems pretty cheap when you consider the potential movement around the upcoming events, and of course the SPX’s 9.25% rally from the Sept 29th lows.
Bottom line, for those looking to pick a direction, SPY options look cheap in both dollar and vol terms. For instance the Nov 6th weekly 204/196 put spread is offered at $1.75 (stock ref $204.50) and breaks-even at $202.25, down 1.1% and offers protection down to $196 down about 4% for less than 1% of the etf price. As always, to do this sort of tactical hedge too frequently, this would be a huge drag on equity returns, but to do so at potential inflection points, in front of potentially volatile events after such a big run could be downright practical.