A 40-point rally on the S&P meant nothing Friday morning.
The S&P 500 was up 40, and the chat room wanted to call it a bounce. I told them “40 points means nothing when you have a hundred and thirty five dollar expected move.”
The expected move is how far options prices say a stock or index will travel by a certain date. Right after Thursday’s close, SPX options were pricing in a $135 move for Friday alone. The expected move for this entire week was only about $168.
Somebody in the room asked about capitulation, the moment sellers give up and dump everything at once. Did you see capitulation Thursday? The financials marked an all-time high that day, while the Nasdaq fell more than 5%. “We’re just getting going.”
118 Is Still A Catastrophic Number
Look past the S&P, and the volatility market is still freaking out.
The VVIX measures how wildly traders expect the VIX itself to swing, so it’s the fear gauge for the fear gauge. It shot to 135 on Thursday. On Friday it pulled back to 118, and 118 is still a catastrophically high number.
The volatility futures are inverted, too. The November contract is priced above December, which is called backwardation, and it means traders are paying more for protection now than for protection later. “As long as the volatility futures are in backwardation, you trust in the fact that the S&Ps are going to be Mr. Toad’s wild ride.”
And watch who sells into these bounces. A whole faction of traders went from buying every dip to looking at every rally like “this is my opportunity, and maybe my only opportunity, to get out.”
Nobody Gets Good Prices In Volatility
So I’m trading the rotation instead of chasing Friday’s bounce.
My XLU position, a bet that money would rotate into utilities, was up 38% Friday morning. I’m working an exit at $1.15 against my 74-cent entry.
On the other side, I shorted 400 more shares of the XLF, the financials ETF, at an average of $57.35. Financials sitting near all-time highs in the middle of a sell-off are where I expect the next round of selling to show up.
You won’t catch the high or the low in this. “Nobody gets good prices in volatility. That’s why it’s volatility.” What you can do is keep your risk small enough that you never need the market to do something for you.
Read The Volatility Before You Trade
Telling a real rally from a trap comes down to reading the volatility market before you place the trade. I’ve put everything I use to do that in one place, from how I read the expected move to the spreads I use when volatility explodes, with lessons from Professor Jeff Bierman, Corey Rosenbloom and Brandon Chapman, too.
If Friday had you guessing, this is where you stop guessing.
To your success,
Don Kaufman
P.S. If you learn one thing from it, make it the expected move. It’s the number that told me 40 points meant nothing on Friday. See what’s inside.
