foxex: Panic Button

Chart Advisor | Focus on the Price

Monday, March 16, 2020

1. Volatility poised to continue to record levels

2. When will the bottom arrive?

3. Volatility pricing predicts a wild ride

Market Moves

Once again the broad market stock index futures hit their five-percent downside trading curbs coming out of the weekend, making it two weeks in a row that this has happened. However, unlike last week those indexes closed more than 10 percent lower by the end of the session. The stunning pace of selling does not give any indications that the market is stabilizing despite a 100-basis-point interest rate cut by the Fed, and an unprecedented string of actions to prop up markets.

The full blown bear-market attack on investors left some frightful future indications as well. Consider the following charts of the CBOE Volatility Index (VIX) which closed above 82 today. The last, and only, time that the VIX closed that high was October 27, 2008 at the depth of the news about the financial crisis. These two weekly charts compare the move on the VIX from 2008 with the one right now. The sheer velocity of the VIX move (4 weeks from 20 to 80 instead of 8 weeks) prompts any rational chart reader to seriously consider whether the downward move in the markets is over, or is just getting started.

When Will the Bottom Arrive?

Since the Fed's trillion dollar bonanza from last Thursday wasn't enough, the surprise over-the-weekend rate cuts seemed to be in order. Surprisingly, it may have had the opposite effect from what the Fed Board of Directors may have intended. Consider that even after the fall of Lehman Brothers, or any of the subsequent days that followed, VIX options were never priced with as much implied volatility as they were today. The forward month VIX options, 22 days away from expiration, were priced with 152% implied volatility at their highest closing price. That represented a 16% chance that the index could move as much as 25 points higher (to 105) in that time frame, though it never did.

Consider that at today's closing bell, the 22-days-to-expiration options closed with nearly 235% implied volatility, representing a 16% chance that the VIX could move as high as 125 in that time frame. Option pricing isn't an exact science where time frames and price levels are concerned, however option market makers are fairly excellent (better than Vegas actually) at setting the probabilities on which they price their offerings. So it makes sense to look closely at what those market odds-makers are publishing today.

The two charts below are based on data and basic images from TDAmeritrade's thinkorswim platform, which shows a probability study based on the option prices at today's close. The odd shape on this chart shows a boundary of the 50-percent-probable outcomes. The scales compare VIX levels on the y-axis and calendar days forward on the x-axis. The peak of this shape coincides with forty days out and the upper boundary shows 100. So based on the option pricing of the VIX options available today, there is a 50-50 chance that the VIX will stay under 100 for the next 40 days. Unfortunately, that means there is a coin-flip chance that it won't.

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Volatility Pricing Predicts a Wild Ride

Recall than in 2008, even after the market (and the VIX) had its worst single day, the S&P 500 index (SPX) would take four and a half more months before it reached its final nadir. During that volatile time, prices would rise 20 percent higher, then fall 40 percent lower from that swing-high mark before making the ultimate low price on March 9th. While investors who have held on from that day are happy now, they were frightening times back then.

The chart below shows another look at the VIX pricing. This study compares the probability the VIX will even touch a certain level during the next 40 days. Amazingly, this chart shows that, based on the current day's option pricing, the VIX only has a 40 percent chance of touching the 40 level (a historically bearish level on its own) at best within the next month. That's the good news. Investors beware.

The Bottom Line

The bad news for buy-and-hold investors seems to be that as bad as it is, things are about to get worse before they get better, and it may be a very wild ride until then. While the markets could get over this panic tomorrow (hey, anything could happen) the people who make their living trying to put their money where their guesses are say otherwise. Options market makers for the CBOE Volatility Index are currently pricing in more volatility than the markets experienced in 2008.