This ETF Flaw Caused Subscribers a 30% Loss, But we Fought Back

I am about to share the worst trade of my carrier with you. It cost me a fair amount of sleep (and probably cost me a number of subscribers, who must have thought Simon is quite the moron).

Here is the sad tale of a good trade hijacked by an ETF flaw (fortunately there’s a happy ending).

The Setup

Earlier this year, in mid-January, we saw a number of VIX extremes, such as highly elevated SKEW readings (SKEW measures ‘black swan’ risk), near-record SKEW/VIX ratio readings and the highest ever long exposure of commercial VIX traders (smart money). The charts below, published by the Proift Radar Report in January, illustrate the extremes.

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Bussines Daily says “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s Profit Radar Report.

Statistically, those conditions led to an average VIX spike of 22% over the next month every time (even a week later the VIX was higher 85% of the time).

The biggest problem (which we were well aware of) was the lack of a suitable trading vehicle for long VIX exposure. Yes, there is VXX, but it suffers from contango (we have often successfully shorted the VIX via XIV, which puts contango in our favor, more about XIV below).

What is Contango?

Below is a brief explanation of contango (taken from an August 2014 report):

The VIX quoted in-day-to-day life is the CBOE Volatility Index (VIX) spot price (today’s VIX price). However, the futures used to create ETPs like the iPath S&P 500 Short-Term VIX Futures ETN (VXX) are based on the future VIX price, which is almost always more expensive than the spot price. Over time the more expensive VIX futures decline in value, eventually converging with the spot price at expiration.

The chart below compares the current spot price with various futures prices. The difference between the spot price (12.20) and the September futures (13.45) is 9.84%. In other words, it will take a 9.84% move in the VIX to neutralize the time decay between the spot and September futures price.

As time goes by, ETF providers are forced to continuously replace expiring futures with new (more expensive) futures (this process is called ‘rolling over’). The further away the futures expiration date, the bigger the time premium. This time premium and resulting value decay is called contango.

Contango vs the Setup

Despite contango, the VIX buy signal seemed strong enough to deliver a net gain (a 20% short-term VIX spike tends to translate into a 5-7% VXX gain). We were looking for a short-term VIX spike, before a multi-week S&P 500 rally.

On January 23, we pulled the trigger and bought a very small amount of VXX at 20.60. A week later, the VIX traded higher, and a month later, the VIX traded higher. The VIX even spiked 22% (as expected) a number of times, but VXX contango persistently eroded VXX.

VXX by-passed the short-term VIX spike, and then, as anticipated, the stock market continued higher (which kept the VIX depressed). Nevertheless, we expected a period of choppy trading (volatility) to start in February/March.

On March 1, the S&P 500 topped, and has basically been range bound since.

On March 23, it was obvious that the VIX would fall again before the next window for a S&P 500 correction arrived. We bought XIV to hedge VXX, which turned out to be a great move.

The Next Window

The window to unwind this unfortunate VIX trade finally arrived this week. The May 14 Profit Radar Report stated that: “We are still looking to sell XIV and double up on VXX at S&P 2,407. Aggressive traders may elect to short the S&P around 2,410.”

Unfortunately there was another blow. The S&P 500 missed our trigger level for XIV and VXX (2,407) by one point (on Tuesday, March 16). The S&P gapped lower the next morning (by 17 points), robbing us of the best opportunity to unwind this trade.

We took the second-best opportunity. The March 17 intraday Profit Radar Report recommended to sell XIV at 77.40, and double up on VXX at 14.45. We closed XIV for a profit of 12.17% and bought VXX at 14.45.

The next morning (Thursday, March 18) we closed our entire VXX trade at 15.97. The VXX portion bought on January 23 accrued a 22.47% loss, the VXX portion bought on May 17 ended with a 10.51% gain. The 11.96% loss was offset by the 12.17% XIV gain.

At the end, we closed this unfortunate trade combo with a tiny 0.21% gain.

Lessons Learned

Patience and impeccable timing (at the end) rescued this trade, but in hindsight, the best worst trade is one not taken.

Contango needs to be respected. In the past, we traded XIV six times (XIV benefits from contango). All six XIV trades were profitable (12.17%, 14.46%, 13.33%, 7.57%, 15.70%, 4.49%). It’s better to focus on XIV (falling VIX) than VXX (rising VIX), especially in a bull market.

Although we knew that the VIX would fall mid-term, we bet on a short-term rise. It’s not smart to bet against the larger trend.

With the VXX trade closed at a miniscule profit, we keep our streak of no losing trade (since June 2015) alive.

The Profit Radar Report provides about 20 specific trade setups per year.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s profile of the Profit Radar Report). The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, and 24.52% in 2015.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

 

The Spectacular VIX Tailwind Trade

This is a reprint of the August 24 Special Profit Radar Report:

The CBOE Volatility Index (VIX) is a popular index, but in itself is not investable. You can’t just go out and buy the VIX. The same is true for the S&P 500 or any other index.

But investment vehicles like the SPDR S&P 500 ETF, which aims to replicate the performance of the S&P 500 index, make it possible to invest in indexes.

Duplicating the performance of the S&P 500, however, is much easier than creating a vehicle that mimics the VIX. Fund managers simply purchase the stocks that make up the S&P 500 to create an S&P 500-like product.

It doesn’t work like this for the VIX. Here’s why:

There is no ‘VIX stock.’ The only way to invest in the VIX is via futures or options, which are complex financial instruments. ETFs, ETNs or other ETP’s use futures or options to attain ‘VIX-like’ performance. VIX futures and options generally suffer from some sort of time decay.

Explained: Contango

The VIX quoted in-day-to-day life is the CBOE Volatility Index (VIX) spot price (today’s VIX price). However, the futures used to create ETPs like the iPath S&P 500 VIX Short-Term Futures ETN (VXX) are based on the future VIX price, which is almost always more expensive than the spot price. Over time the more expensive VIX futures decline in value, eventually converging with the spot price at expiration.

Figure 1 compares the current spot price with various futures prices. The difference between the spot price (12.20) and the September futures (13.45) is 9.84%. In other words, it will take a 9.84% move in the VIX to neutralize the time decay between the spot and September futures price.

As time goes by, ETF providers are forced to continuously replace expiring futures with new (more expensive) futures (this process is called ‘rolling over’). The further away the futures expiration date, the bigger the time premium. This time premium and resulting value decay is called contango.

Contango generally exists when the VIX is flat or trending lower. Even gradual increases when the VIX is below 20 tend to occur in an environment of contango.

Backwardation (figure 2) is the opposite of contango. Backwardation generally appears only during times of panic and significant VIX spikes above 20.

To sum up, contango erodes investors’ returns during periods of a flat or falling VIX.

How to Profit from Contango

We don’t expect a major stock market top yet, therefore the period of low volatility is likely to continue (or resume after the seasonal October VIX high).

Is it possible to use contango in our favor?

Figure 3 plots the VIX against the VelocityShares Daily Inverse VIX Short-Term ETN (XIV), and reveals a very simple truth: XIV has risen much more than the VIX has fallen.

Figure 4 shows the cumulative gain/loss from January 3, 2011 to August 15, 2014. The VIX lost 25%. XIV gained 242%. XIV returned 217% more than the inverse VIX.

XIV’s objective (and the objective of every other inverse or leveraged ETP) is to replicate the daily (not long-term) inverse performance of the VIX, but regardless, this kind of excess return is worth exploring.

Here is a more detailed breakdown of XIV’s excess return.

XIV is an inverse VIX ETN. For an apples to apples comparison, we are comparing XIV with a simple inverse VIX.

Of the 911 trading days from January 3, 2011 to August 15, 2014, the inverse VIX had 484 up days and 427 down days. The inverse VIX had 1.13x more up than down days.

The average gain of 484 up days was 4.55%. The average loss of 427 down days was 5.85%. The average loss was 1.28x greater than the average gain.

Of the 911 trading days from January 3, 2011 to August 15, 2014, XIV had 522 up days and 389 down days. XIV had 1.34x more up than down days.

The average gain of 522 up days was 2.63%. The average loss of 389 down days was 3.18%. The average loss was 1.21x greater than the average gain (see figures 5 and 6).

Summary

Since 2011, XIV outperformed the inverse VIX by 217% (0.24% per day). Although there are other factors at work, the excess return of 0.24% per day is largely attributed to the effect of contango.

Contango does not guarantee a profitable trade or protect against losses. From July 7 – November 21, 2011 XIV lost 75%. There are also times where the VIX moves lower and XIV loses value (i.e. August 18 – 21, 2014).

Over time however, contango significantly enhances the odds of a successful XIV trade, especially when XIV is purchased during times of VIX spikes.

A list of VIX Exchange Traded Products that benefit from contango, a updated VIX seasonality chart, and actual buy/sell signals are available via the Profit Radar Report.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s profile of the Profit Radar Report). The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, and 24.52% in 2015.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Contrarian Indicator? Longer-term VIX Fears Far Outweigh Short-term Concerns

Investors are more concerned about implied 3-month S&P 500 volatility than 1-month volatility. How do we know that?

The ratio between the CBOE Volatility Index (VIX) and CBOE S&P 500 3-month Volatility Index (VXV) was just at 0.79, the lowest reading in 2015.

It is a sign of complacency when investors are more concerned about 3-month than 1-month volatility. Is it also a contrarian indicator?

The chart below plots the VIX:VXV ratio against the S&P 500 (NYSEArca: SPY). The dashed red lines mark all sub 0.80 readings since 2010. There were only four similar signals since the beginning of 2013. While not flat out wrong, the signals came either a bit too late or didn’t result in noteworthy weakness.

The VIX:VXV ratio is more valuable for bottom fishers than top pickers. Spikes above 1.1 have been more predictive of tradable lows than sub 0.8 readings of tradable tops.

What about overall investor sentiment? Is overall investor sentiment worrisome? Here is a detailed look at six different investor sentiment gauges:

Should We be Worried about ‘Smart Money’ Leaving Stocks?

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Market Pulse: Is Investor Sentiment Really ‘Dangerously Bullish’?

How bullish are investors really? There are different types of investors, individual investors, institutional investors, traders, smart money, dumb money … and there’s a gauge for each group. Here’s a look at six different investor sentiment indicators.

The market has been stuck in yet another waiting pattern, so we might as well use the time to look at the forces that may (or may not) jolt stocks out of their waiting loop.

According to many, overheated investor sentiment will break the stale mate and send stocks spiraling lower.

There’s just one flaw with this line of reasoning. Sentiment is not overheated.

The Profit Radar Report continuously analyzes how investors feel about stocks and publishes a comprehensive sentiment picture once a month.

The chart below, which plots the following six sentiment gauges against the S&P 500 (NYSEArca: SPY), was published in the August Sentiment Picture on August 29:

  • CBOE SKEW
  • Equity put/call ratio
  • CBOE Volatility Index (VIX)
  • NAAIM survey of active money managers
  • II survey of investment advisors
  • AAII survey of individual investors

Where are the sentiment extremes?

There’s only one: Last week 51.92% of individual investors were bullish. That’s the highest reading since December 24, 2013. The red lines highlight other 50%+ spikes and how the S&P 500 reacted.

Yes, the bullish December AAII reading was followed by a January pullback, but there’s a big difference between today and December: No other indicator is confirming August’s AAII spout of enthusiasm, and AAII bulls are back down to 44.70%.

There was one more extreme not illustrated by the chart: The percentage of bearish investment advisors polled by II dropped to 13.3%, the lowest reading since 1987. This is a legitimate extreme.

The August 29 Sentiment Picture summed up the big picture sentiment situation as follows:

Perhaps most noteworthy is that we continue to see isolated sentiment extremes, but the source of such extremes only rotates (the SKEW and put/call ratio in July, the AAII poll in August), it doesn’t compound. We see different gauges hit overheated levels at different times, but never all at the same time.

The overall sentiment picture is fractured, and void of the ‘all in’ mentality seen near major market tops.

Isolated extremes cause only small pullbacks here or there.

Based on sentiment, we could see 1) a continued grind higher interrupted by the occasional 3-10% correction or 2) a prolonged period of choppy sideways trading.”

Bottom line, sentiment is not extreme enough for a big scale market top.

The most important market breadth indicator, which correctly foreshadowed the 1987, 2000 and 2007 crashes, also doesn’t show the deterioration needed for another crash.

More details about this must-know indicator can be found here: How to Discern a Major Market Top

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

VIX Seasonality Sports Brief Bearish Window

The CBOE Volatility Index, or VIX, has been following its general seasonal pattern rather closely, especially since the seasonal VIX low in July. Within a larger seasonally bullish period, there is a brief bearish window that may draw the VIX lower.

VIX seasonality has been an indicator worth watching.

The VIX seasonality chart projected a major seasonal low on July 9.

On July 10, the VIX spiked as much as 9.8% and on July 17, the VIX soared as much as 41.7%.

From the July 2 low at 10.28 to the August 1 high of 17.57 the VIX gained 71%.

Despite bullish VIX seasonality, the early August spike seemed overdone. The August 1 Profit Radar Report stated that:

“The VIX spiked 27% today, a kneejerk reaction similar to that of July 17. We would actually like to see another VIX spike sometime in August, and if we do we will likely buy the VelocityShares Inverse VIX ETN (NYSEArca: XIV). XIV benefits from a declining VIX.”

Here are some interesting behavioral VIX nuances:

  • Although the S&P 500 (NYSEArca: SPY) saw another low on August 7, the VIX high of August 1 remain intact.
  • Although the August 1 VIX high remained in tact, XIV dropped to another low on August 7 (the August 6 Profit Radar Report recommended to buy XIV at 35.10).

The chart below plots the VIX against XIV. Sideways trading following the August 1 VIX high resulted in lower XIV prices.

This deviation is caused by contango. Contango generally favors bearish VIX bets. Click here for a detailed explanation of contango.

Summary:

  • The VIX seasonality chart allows the following conclusions:
  • July 9 – October 9 are bullish for the VIX.
  • Within this bullish 3-month zone, there is a brief window of bearish seasonality from August 7 – August 22.
  • Any VIX rally into early October should provide a good opportunity to short the VIX.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

VIX Ratio Shows Less Short-term Than Long-term Fear

Just about every investor is familiar with the VIX. What many don’t know is that there is a short-term VIX and a longer-term VIX. Calculating the ratio of the short-and long-term VIX shows us if volatility traders are more concerned about the short or long-term.

Here’s a unique take at the CBOE Volatility Index or VIX in correlation with its lesser-known cousin, the CBOE S&P 500 3-month Volatility VXV (Chicago Options: ^VXV).

The VIX (NYSEArca: VXX) is a gauge of expected volatility for the next month.

The VXV is a gauge of expected volatility for the next three month.

The VIX / VXV ratio lets us know if volatility traders are more concerned about the short-term (1 month) or long-term (3 month).

As with most everything VIX related, this works better as a contrarian indicator.

The S&P 500 / VIX / VXX Ratio chart below plots the S&P 500 (SNP: ^GSPC) against the VIX/VXV Ratio.

As of Friday, the VIX/VXV Ratio dropped to 0.87. This basically means that volatility traders expect less volatility over the month compared to the 3 month.

The ratio is not yet extreme, but it’s close to the 0.856 reading that coincided with the September high.

Since 2011, the S&P 500 (NYSEArca: SPY) has struggled when the VIX/VXV ratio was around and below 0.82.

Based on the VIX/VXV Ratio, the S&P 500 is approaching a level where caution is warranted. Further insight is provided by VIX seasonality.

VIX Seasonality

The last time we looked at our proprietary VIX seasonality chart was on October 8. At the time, VIX seasonality suggested a minor VIX (NYSEArca: TVIX) high and a bounce for stocks.

VIX seasonality kept us on the right side of the trade in early October, but the real big seasonal VIX turning point is still coming up.

The VIX seasonality chart (available here: VIX seasonality chart) highlights the second-best seasonal VIX trade of the year.

Simon Maierhofer is the publisher of the Profit Radar Report.

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A Detailed Look at 5 Different Sentiment Gauges

If you want to know how much money is waiting on the sidelines to drive stocks higher, take a look at various sentiment measures. Combine those sentiment measures with actual money flow gauges and you’ll get a good idea of how much cash is left (or not) waiting to buoy the stock market.

Seasoned investors look at many indicators before making buy/sell decisions. One of them should be sentiment.

My personal ‘three pillars of market forecasting’ are technical analysis, seasonality, and sentiment.

Technical analysis includes trend lines, patterns (like triangle, head-and shoulders, etc.), Fibonacci levels, divergences and so on.

Seasonality includes seasonal patterns and cycles for broad indexes and sometimes individual stocks and sectors.

Sentiment can be subdivided into many segments. I consistently follow more than a dozen sentiment and money flow gauges and regularly chart the following five for Profit Radar Report subscribers:

CBOE Volatility Index (VIX)
CBOE Skew Index
CBOE Equity Put/Call Ratio
% of bullish advisors polled by Investors Intelligence (II)
% of bullish investors polled by the American Association for Individual Investors (AAII)

The chart below is a reprint of the July 25 Sentiment Picture (available to subscribers of the Profit Radar Report).

It plots the S&P 500  against the above-mentioned sentiment gauges.

The VIX (NYSEArca: VXX) continues to linger near a multi-year low. This has been the case for almost a year. Using the VIX to time market highs has been a fool’s errand. We realized that back in November 2012 when the Sentiment Picture ‘quarantined’ the VIX:

“When an indicator doesn’t work, we’ll put it on ‘probation’ until it proves its worth again.” Let’s just say the VIX has continued to be on probabation.

The put/call ratio is a valuable member of the sentiment family. The May 19 Sentiment Picture noted that option traders were finally jumping on the rally bandwagon and warned that: “Risk is rising. A fair portion of current gains should be quickly retraced.” The S&P 500 (NYSEArca: SPY) quickly lost 7% thereafter before rebounding.

Sentiment polls by Investors Intelligence (II) and the American Association of Individual Investors (AAII) are a ‘casualty’ of the QE liquidity market and need to be taken with a grain of salt.

Extreme bullishness reflected in the polls hasn’t had much of an impact on stocks, but bearish extremes have coincided with rallies.

The April 26 Sentiment Picture for example picked up on the extremely bearish AAII poll numbers and the large number of II folks looking for a correction and wrote:

“36% of advisors and newsletter writers polled by Investor’s Intelligence (II) are looking for a correction. Incidentally, that’s exactly what we are expecting. However, the market rarely fulfills the expectation of the masses.” In other words: expect higher prices.

It took years of trial and error to become familiar with the various sentiment gauges and learn how to interpret the different readings. I have found that there’s a difference between sentiment polls and money flow indicators. The equity put/call ratio, for example, is an indicator that shows if investers are really ‘putting their money where their mouth (sentiment polls) is.’

When the put/call ratio finally reached extreme territory in May (and investors started to put their money where their mouth is), the stock market turned sour, at least temporarily. A updated chart and analysis of the equity put/call ratio is available here: “Is a Market Top Near? ‘Smart’ Option Traders Send a Curious Message.

Continuous sentiment analysis is available via the Profit Radar Report.

VIX Analysis – The Misleading Message of the Golden Cross

Things aren’t always what they seem. That’s certainly true with the golden VIX cross. It sports an absolutely flawless record since 2008. However, digging deeper reveals the flaws of this seemingly flawless indicator.

Golden crosses or ominous death crosses tend to grab Wall Street’s attention. The CBOE Volatility Index or VIX just saw a golden cross.

A golden cross occurs when the 50-day simple moving average (SMA) crosses above the 200-day SMA (a death cross occurs when the 50-day SMA drops below the 200-day SMA).

A golden cross for stocks, indexes or ETFs is generally considered a bullish development. Since the VIX serves as a fear barometer (the higher the VIX, the more fear), a golden VIX cross is actually considered bearish for stocks.

The Bi-Polar VIX Golden Cross

Since 2008 a golden VIX cross has foreshadowed lower stock prices 100% of the time. As the chart illustrates, the 50-day VIX SMA crossed the 200-day SMA on 9-17-2008, 5-26-2010 and 7-26-2011.

One month later the S&P 500 traded lower every time. In 2008 and 2011 the S&P 500 losses easily reached double digits. Based on analysis going back to 2008 the golden VIX cross is a definite negative for stocks.

There were 24 golden VIX crosses from 1987 – 2007. Unfortunately, that’s too long of a time span to easily illustrate via a chart.

Nevertheless, a thorough examination of those 24 instances reveals no bearish implications for stocks. In fact, buying the VIX (or selling the S&P 500) based on the signals prior to 2008 would have racked up more losses than gains.

Such a poor track record is not surprising. After all the VIX is mean-reverting, so betting on the continuation of a trend suggested by a long-term moving average is counter intuitive.

While I don’t base my analysis on the VIX golden cross, the general behavior of the VIX, the S&P 500 and Treasuries may suggest that the nature of the market is changing and that lower lows are still ahead for stocks.

The June 18, Profit Radar Reported plainly recommended that: “We will go short with a move below S&P 1,635. We will also go short the Nasdaq-100 with a move below 2,970.”

>> click here to test drive the Profit Radar Report.

Despite Extreme VIX Movements, Option Traders are ‘Lukewarm’

According to the VIX, option-traders are complacent and have been complacent for many months. The bearish VIX implications however, have not been confirmed by two historically accurate options-based sentiment indicators.

The VIX soared 43% on Monday, collapsed 19% on Tuesday and is up nearly 30% today. Just before that, the VIX fell to the lowest reading since February 2007.

Although the CBOE Volatility Index (VIX) is rushing from one extreme to the next, options traders as a whole have been remarkably ‘non-committal’ or lukewarm from a sentiment point of view.

This sentiment deviation is illustrated by the chart below. The CBOE Equity Put/Call Ratio has been narrowing in a triangle shape formation void of extremes. The 2010, 2011 and 2012 market highs were preceded by at least one daily reading below 0.5 and a drop of the 10-day SMA below or at least close to 0.55.

The 2013 Equity Put/Call Ratio low was at 0.54 on March 6 (the 10-SMA has yet to fall below 0.6). The recent all-time highs caused no put/call sentiment extremes.

Quite to the contrary, the VIX has rushed from one extreme to the next. For that reason, the Profit Radar Report noted back in November that the: “VIX has been of no use as a contrarian indicator and will be put on ‘probation’ until it proves its worth again.” Yes, the VIX is still on probation.

A SKEWed Market?

The CBOE publishes another options-based index like the VIX, it’s called the CBOE SKEW Index. The SKEW in essence estimates the probability of a large decline.

Readings of 135+ suggest a 12% chance of a large decline (two standard deviations). A reading of 115 or less suggests a 6% chance of a large decline. In short, the higher the SKEW, the greater the risk for stocks.

The chart below juxtaposes the SKEW against the S&P 500. Last week the SKEW fell as low as 117. This was odd as readings below 115 (dashed green line) are generally bullish for stocks.

Conclusion

The CBOE Equity Put/Call Ratio and SKEW index proved to be valuable contrarian indicators in 2010, 2011 and 2012. The current option-trader sentiment is not bullish, but it’s not as bearish as one would expect to see at a major market top.

To an extent, option-trader sentiment is in conflict with other bearish sentiment extremes discussed recently. When sentiment indicators conflict, technical analysis and support/resistance levels become even more valuable.

The April 10, Profit Radar Report highlighted key resistance at 1,593 and stated that: “A move above 1,593 followed by a move back below 1,590 will be a sell (as in go short) signal.”

As long as prices remain below key resistance, the trend is down until stocks find key support.

VIX Seasonality Suggests Higher Readings

The VIX is back to 2007 levels and actively defying the contrarian implications of extra low VIX readings. Will the VIX drop much further? A look at VIX seasonality provides some clues.

When complacency reigns, investors get wet or at least so goes the saying. The CBOE Volatility Index (VIX) has been trading below 15 for all of 2013, but the only ones getting ‘wet’ are VIX bulls and stock bears.

Still, the VIX is at a 73-month low and eventually there’s some money to be made buying VIX calls or long VIX ETFs. When will that be? VIX seasonality provides some clues.

VIX Seasonality

The first chart provides a visual of VIX seasonality based on data from 1990 – 2012. A devisor has been used to equally weigh each years’ performance.

In an average year, the VIX has seasonal lows in early and late February before spiking to an early March high. This would provide a short window for a seasonal move higher.

The average February to March VIX spike is less than 10%. Obviously, there’s more potential upside in 2013 as the debt and deficit ceiling quandary has the potential to springboard the VIX from its 73-month low.

However, the VIX seasonality chart suggests to eat your ice cream before it melts. In other words, locking in any gains (or carefully managing any gains) before the early-March seasonal high is prudent.

S&P 500 Seasonality

Most of the time there’s an inverse correlation between the VIX and the S&P 500. When the VIX goes down, stocks go up and vice versa.

Does S&P 500 seasonality confirm VIX seasonality? It would in a perfect world, but investing is about odds, not perfection.

The second chart plots overall S&P seasonality (1950 – 2012) and post election year seasonality against VIX seasonality. VIX seasonality (blue line) is inverted for easier comparison of trends.

The dashed red lines mark three trends that line up. One is a mild early-to mid February sell signal (sell signal for stocks, not VIX) followed by a weak late June buy signal and a strong October buy signal.

S&P seasonality also suggests that any February correction may be short-lived.

Seasonality charts capture the general trends of more than six decades and averaging of trends eliminates a lot of ‘seasonal noise’ along with potential setups.

Nevertheless, when seasonality agrees with other indicators (like sentiment, technicals, fundamentals) we get a stronger signal. This could be the case right now.

Long VIX ETPs include the iPath S&P 500 Short-Term Futures ETN (VXX) and VelocityShares Daily 2x VIX Short Term ETN (TVIX).

Short S&P 500 ETFs include the Short S&P 500 ProShares (SH) and UltraShort S&P 500 ProShares (SDS).