S&P futures go for lucky 7!
Fundamentals
The old saying "All good things must come to an end" certainly has not applied to the S&P futures market lately, as the bounce off recent lows has lasted seven consecutive days. The announcement from the FOMC meeting added to the recent bullish recovery, as the Federal Reserve announced it will buy up to 300 billion in longer term Treasuries as well as bolster programs to help lower mortgage rates. Now the questions will turn to whether the recent rally attempt is nothing more than a "dead cat bounce" in a major bear market, or a sign that an economic recovery is within view, possibly later this year. Although valid arguments can be made to support both sides, with bulls noting the surprise rise in U.S. housing starts last month as a sign that the worst may be over for the U.S. housing market, which in turn would be a big boost for economic revival -- and bears countering continued weak readings of U.S. industrial production and almost daily announcements of corporate layoffs showing that a recovery is still down the road. One thing that is apparent is that the sharp volatility that the stock market has experienced in the final quarter of 2008 has begun to level off, though at generally elevated levels compared to the past several years. A chart of the CBOE volatility index or VIX shows volatility levels moving into an increasing narrow triangle formation since the end of last year. Although the S&P 500 made new lows during this time frame, the wild daily price swings have generally been absent. The average daily volume in the SPDR S&P 500 (SPY) has shown an overall decline during this time, but has been noticeably weak -- except for yesterday, during the rally of the past several days.
With the market seemingly at a near-term crossroads and volatility near the low end of the recent range, a trader looking for a big move in the S&P futures or a sharp increase in volatility may want to look at the purchase of E-mini S&P futures options straddles. An example would be buying the May E-mini S&P 775 straddle currently trading around 95 points ($4750 per contract). These options currently have 57 days to expiration and to be profitable at expiration would require the June E-mini futures to be trading above 870 or below 680. However, many buyers of straddles are looking for a sharp rise in implied volatility to occur within the first couple of weeks after the trade is placed to limit the effects of time decay on the position.
Technicals
Today we are going to take a look at a daily chart of the VIX index mentioned in my earlier commentary. Notice the symmetrical triangle formation that formed the past several months after volatility rose to historic levels starting in October. This recent period of "calm" came despite the S&P futures falling to multi-year lows. It is interesting to see that only 1 year ago, volatility was trading around 25 or below! If the recent rally in the S&P's were to continue, the odds of the VIX falling below the recent lows of 37.34 are likely. However, should this rally turn out to be nothing more than a bear market rally, we could see the VIX try to test resistance at the upper part of the triangle formation near the 52 level.
Mike Zarembski, Senior Commodity Analyst
