foxex: Forecast Higher

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Monday, April 27, 2020

1. VIX falls as stocks inch higher

2. Oil volatility signaling problem not solved

3. Grounded airlines can't take off yet

Market Moves

Both large-cap and small-cap stocks rallied today while bond prices fell and oil prices dropped sharply. Small and micro-cap stocks were up nearly four percent on news that President Trump signed the next relief round into law.

The chart below shows that option traders appear to be anticipating a move higher in stocks. That forecast is implied when chart watchers observe the CBOE Volatility Index (VIX) diverge meaningfully from the S&P 500 index (SPX). The VIX index has made new relative lows over the past two days while State Street's S&P 500 index ETF (SPY) has yet to clearly break above its recent swing high.

This divergence is significant because option prices are heavily influenced by investor demand for put options as opposed to call options. The more put options traders buy, the more professional option sellers tend to increase their premiums on all options. However, if option sellers are lowering their premiums (which in turn would drive the VIX lower), then they are expecting fewer people to buy put options. It follows that those option sellers believe investors are likely to lift prices higher.

Oil Volatility Signaling Problem Not Solved
Though the extremely unusual events taking place in the oil futures market are more than two trading days' past, the bigger problem in oil prices and worldwide production has not yet been fully addressed. Crude oil dropped $4 a barrel in price today, representing a 24% fall from its previous close (see chart below).

Even though the drop from $30 a barrel to $20 dollars a barrel was a dramatic fall during the previous month, the past two trading sessions have been even more brutal to oil producers. The charts below compare oil prices in one-hour time-frames before and after Thursday's unusual collapse. These charts show the Average True Range for each hour as a percentage of the price, so that they can be more accurately compared by the two blue lines below each chart.

Before Thursday's below-zero trading price for crude oil was printed, the commodity price was fluctuating between two and five percent each hour. However, the past two trading sessions have featured trading in the range of four to six percent each hour. This extreme volatility has a simple message: there is too much supply and not enough demand for oil, and no one is fully sure how to fix it.

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Grounded Airlines Can't Take Off Yet

Before those problems in the oil markets are solved in any meaningful way, airline travel will have to regain even a fractional degree of normalcy. Many are expecting that the airline companies will be bailed out by the U.S. Government, and thus buying their stock now represents a good opportunity to buy at low prices.

The chart below is an equal-weighted portfolio of the three major airlines, Delta (DAL), Continental United (UAL), and American (AAL). Chart watchers are not oblivious to the fact that the prices for these stocks are essentially on sale, two-thirds off. But just because something is a comparative bargain, doesn't mean it is a good deal. The reason for the pricing is that even with government assistance, it is quite possible that one of these three companies might be forced to declare bankruptcy. So much depends on when demand for air travel might resume.

With Delta having reported earnings already, and the other two airlines slated to do so this week, we might see the first signs that investors are ready to anticipate the industry's comeback. Not until then will the problems in the oil markets likely begin to diminish.

The Bottom Line

Stocks are rising even as oil markets continue their volatility. Option buyers anticipate that prices will continue to rise. Oil prices will likely not settle down until the market gets some indication that the major airlines are on a path to recovery.