The blame game of why the market is off in Monday’s second half following a rousing good start to the week certainly has a couple easy suspects to point fingers at. For one and after celebrating overseas, investors are coming to realize the $125.0B injected into Spain’s banking system may still not be enough action to prevent further damage to the country’s battered financials. Likely concerns of other Debt PIIGS also requiring further bailout monies in the weeks / months ahead and of course and uncertainty surrounding Greece as it nears its governmental revote over the weekend are also easy enough targets to rework today's early market enthusiasm.
In our eyes though, enemy number one for bulls moving like they’re readying for a day in Pamplona, the CBOE Volatility Index is an ever-likely candidate for today’s failed rally effort. Out-the-gate lows approaching 19.5% pushed the mean-reverting sentiment index more than 16.5% below its 10SMA. Differentials in excess of 15% are prone to a reaction in the other direction as investor emotion looks to typically normalize itself on a relative or short-term basis, which in turn is best expressed as a relationship to its 10SMA.
Figure 1: CBOE Volatility Index ($VIX) Daily
There are no absolutes or guarantees in the market with regards to one tool working with 100% success. Nonetheless, in our years observing traders turn from bull-to-bear and vice versa, watching the VIX for a signal is a solid one to watch for and more often than not gets it right as far as being a contrarian tool. And in this particular occasion, in conjunction with the “stretch” also testing a one month low below the well-watched 20% level into potential Bollinger, Fibonacci and 50SMA support after striking a near perfect and fearful double the prior Friday; watching the VIX has made all the more sense and likely cents once more.
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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