Thursday, April 02, 2020 1. Indexes up but utility sector up more 2. When implied volatility is too high 3. When historical volatility is too much Market Moves Stock indexes all rose two percentage points higher today on the heels of a 24% oil-price surge kicked off by President Trump's tweet. Bond prices and Gold traded higher as well, giving support for the notion that the disarray in the oil markets is the primary threat facing investors right now.
Not even the news that the Purchasing Managers Index (PMI) published, not unexpectedly, its worst reading since the financial crisis, couldn't hold investors back from buying up everything being sold today. In a bit of a surprise move, Utility sector stocks outperformed the broad market indexes, closing 3% higher today.
The chart below shows the comparison of State Street's Utility sector index ETF (XLU), with an S&P 500 growth fund (SPYG), an S&P 500 value fund (SPYV), and iShares Russell 2000 index ETF (IWM). Chart watchers would expect XLU to not fall as far as the others, however they would not expect it to rise off the lows to a greater degree than the others compared here. This move in utilities implies that investors are still quite scared, suggesting that the indexes could still experience significant drops in the near future. That reality will not stop some investors from considering buying in right now, but that may be quite a risky move. When Implied Volatility is Too High Some eager investors may want to jump in and buy the current market conditions, expecting that the rebound will be rapid, pronounced and largely uninterrupted in its ascent. Although such a rebound may happen this way, history suggests this expectation is not likely to be realized.
If you compare State Street's S&P 500 index ETF (SPY) with the CBOE Volatility Index (VIX) by dividing the first by the second (SPY/VIX), then you get the interesting chart shown below. If you add a 52-week Donchian Channel indicator to show when a new yearly low is established, then you have an interesting signal worth considering.
The chart below displays moments when the VIX has moved high enough and fast enough, while at the same time prices have dropped low enough, to create a low stock-to-volatility-index ratio. The lower panel of the chart documents the 52-week return from buying after this signal (click the chart for a larger version).
The signal has occurred 16 times since 1992 when SPY began trading. The average return is over 9% if you set a 10% stop loss on your position, and it runs positive more than 65% of the time.
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When Historical Volatility is Too Much If buying stocks when option prices are historically high and index prices have dropped significantly isn't a foolproof method, is there perhaps a way to improve on it? The chart below is my attempt at that.
If one takes the volatility-to-stock ratio seen in the previous chart, and then maps how often that ratio moves bigger than its usual fluctuation, such a measure would show just how unusual a VIX move was. This measure would compare just how scared people are considering how much the market has moved already. It takes into account both implied and historical volatility. As shown below this measure filters out some of the downward trending moves and leaves a higher incidence of upward moves. This indication averages a 14% return in the following 52 weeks with no drawdown greater than 10%. How can we improve the Chart Advisor? Tell us at chartadvisor@investopedia.com
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Thursday, April 2, 2020
Risky Business
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