Stocks jumped 4% last week as fears over the potential for an Ebola contagion have simmered down at the same time that some solid Q3 earnings reports have combined with better economic data to suggest that the world is not spinning out of control after all.
This has naturally led to a correction of the previous week’s runaway fear that provoked institutional investors to buy copious insurance in the form of put options on the S&P 500 index. As anxiety has dramatically abated, the S&P 500 Volatility Index (VIX) crashed by 25% in five days.
It never fails to amaze me how quickly institutional investors grab for a security blanket when seas get a little rough.
The VIX shot up to 31 (a three-year high) due to a paroxysm of anxiety that the Ebola virus would spread rapidly from across the United States after having initially nested in Dallas, Texas, and somehow reduce corporate earnings enough to cause a market meltdown.
If you think about it a moment, it just makes no sense. And yet you can see that the fear was really a thing, because the VIX didn’t shoot up to the 31 level all by itself. Think of all the other concerns that investors have had in the past three years, ranging from the military and social troubles in the Middle East to the slowdown in the Chinese economy, the U.S. government shutdowns, the debt ceiling and “fiscal cliff” fiascoes and more.
Yet, as you can witness in the chart below, most of those led to VIX spikes of no more than 22.50, with one going to 27.50 — so the spike last week was really something special.
My expectation is that the low of the recent turmoil was hit on Oct. 15 at around the 1,820 level of the S&P 500, and, though it may be tested again in the coming weeks, it should hold once again as sellers step aside and allow buyers to take the S&P 500 back up toward the 1,975 level at least, if not all the way back to 2,000 and higher. U.S. corporate earnings will be negatively impacted by the surge of the dollar, but the past month and a half’s downturn has discounted that, and now it is probably time to discount the recovery.
The CounterPoint Options system recommends playing for a return to a risk-on condition: a volatility decline, a stock rebound and a bond sell-off. Today’s trade is designed to profit from the latter scenario, via put options on the iShares Barclays 7-10 Year Treasury Bond Fund (IEF).
Buy the IEF Dec. 20th $105 puts at current levels (around $1.10) for target $1.50.
Jon Markman operates the investment firm Markman Capital Insights. He also offers a daily trading advisory service, Trader’s Advantage, and CounterPoint Options, a service that helps individual traders make steady, consistent profits with volatility-related instruments.
