Herd Think

Something to think about at these crucial junctions in the markets is the "herd think" and which way they are leaning. One of the most important market sentiment indicators as most of you know is the VIX index AKA the Volatility Index. Currently we are sitting at the lows of the year going back to last fall. Trying to guess where the pros and institutions are placing their bets gives you a good idea what "may" be coming down the pipe.

According to Bernie Schaeffer of Schaeffer's Investment Research, the large options players have massive bets on the markets moving to the downside in a big way just as they did last year at this time and they made a killing. But are they right this time ?

Seems the consensus back a month ago was that this earnings season was going to be disastrous and look what happened. The options shorts got killed and stock shorters had to cover like madmen which only added fuel to the first legs of this most recent rally.

But what happens if they are wrong this September ? As I posted back a few months ago, the "Sell in May" theory didn't work back coming out of the 2002 recession and we saw some phenomenal stock price runs the past 2 months.

The key point to Schaeffer's article is that the big money is overpaying relative to past S&P500 volatility history.

His closing comments sum it all up :

In addition to the "group think" issue, there is also the fact that recent realized volatility is very much supportive of current VIX levels. The 20-day historical volatility of the SPX is currently a shade below 20% compared to a VIX of about 25. I appreciate the fact that a low VIX can also serve to dampen realized volatility, but the fact is that options traders buying SPX puts (and calls) at current "low" levels are actually overpaying relative to recent historical volatility.

The "inevitability of a higher VIX" argument is a very seductive one, and it is supported by some compelling data as suggested above. But – perhaps to the surprise of some of the confident VIX bulls -- predicting the course of future volatility is a very tough game. And I would strongly suggest that you remain open to the possibility that we have not seen the lows in the VIX, and further that it should not be a total shock if we saw a VIX in the teens before it ultimately bottomed and volatility became a "buy" again."



As I always do, check out both sides of the coin no matter how tempting the "herd think" is.