VIX Withers Down Below Technical Support After Huge Job Loss Catalyst

Includes: DIA, EFA, IWM, QQQ, SPY, VTI
by: Investment Pancake

As the saying goes, there’s always a bull market somewhere. The reason why is that capital is neither created nor destroyed by falling or rising asset prices – all that changes is the place where that capital is parked. For example, when equities prices collapse, the price for bonds can rally as capital leaps from the former market and into the latter. Other times, when equity prices are falling off a cliff, capital might flee the equities market and jump over into the commodities market, or perhaps real estate, sending prices for those assets soaring. It's like a big frog made of capital, jumping from one lily pad to the next.

What's been remarkable this year is that the price for almost every asset class in every market on the planet has been falling at the same time. There's no bull market any place this time, and it's like someone has let the water out of the pond. This shouldn’t come as much of a surprise because there’s a lot less credit available these days. Credit, the very stuff by which the price of an asset is driven and denominated. It’s the water in the pond, and now that there’s a lot less of it, all the lily pads are sinking into the mud, and all the capital frogs are dying.

Or so the story goes. What this story leaves out is that there is, in fact, a “stealth” lily pad. If there’s no safe place to preserve capital in the equities, bond, commodities or real estate markets, traders take their capital and park it into a bearish trade, betting that one or more of these markets will fall. For instance, they might buy put options, or options on the CBOE Volatility Index (the “VIX”), or credit default swaps, for instance. And there is a price on a bearish trade, which, just like any other asset, can rise or fall based on demand. The stealth lily pad is, fundamentally, no different from all the other lily pads out there, and if you're wondering where the capital frogs are camped out, look no further.

There are lots of capital frogs on the stealth lily pad and so the price of everything there, such as VIX options, credit default swaps, and other bearish trades, has exploded through the roof. But the thing about a capital market frog is that what it likes best of all is to see the price of all the stuff on the lily pad not just staying high, but going up even higher. The reason why is that clever frogs like to get OFF a lily pad very early on when the price of stuff stops going up, because they know something about themselves. What they know is that capital market frogs are closely related to lemmings. One jumps, pretty soon everybody jumps, and the price of whatever is on that lily pad swoons.

We may be in the very early stages of seeing this scenario start to unfold on the stealth lily pad. For instance, the price of VIX options seems to have hit a wall since the end of October, after an historic rise that was fueled by explosive volume. However, since that time, the price for VIX options has been getting pinned into a narrower, and lower, band. Upward price momentum has stalled out, the volume of transactions has dried up – for instance, Reuters reports options volume has fallen 21.2% from where it was this time last year. The pause that refreshes?

Maybe, but don’t ignore what carries price momentum in any market forward, and that is a good, riveting story. The original story for why the price of VIX options has been going up is that the global banking system is falling into pieces. Then, the story evolved into one about how the global economy is plunging into a depression.

As we turned the page on Friday, we were stunned to learn just how bad the US economy really is, as over half a million jobs were reported lost. That should have been a potent catalyst for the price of VIX options, which surged initially, but then actually fell towards the end of trading just under its 50 day simple moving average. In an upward trend, the 50 day simple moving average often acts as a trading springboard – particularly when a good story line (like unbelievably horrible job losses in the U.S.) helps fuel the trading momentum higher.

However, when the story line starts to get stale, it’s usually about that time when capital market frogs begin looking around for a new story. But some of the earlier ones to leave the party start looking for a new lily pad.

Which they did on Friday, jumping (of all places) into the equities markets instead (including certain equities index exchange traded funds such as VTI, IWM, SPY, DIA, EFA). Whether this trend will continue, the author has not so much as a clue, but I will leave the reader with a happy thought. Suppose the price of VIX options, credit default swaps, and other stuff on the stealth lily pad collapses, while the price for equities, commodities, bonds, and real estate continues to fall... simultaneously?

If that happens, then the water really is draining out of the pond after all, and we may all end up wallowing and croaking in the muck and mire together.

Disclosure: The author owns VTI, IWM, SPY and EFA