22/2/2017 TheScalesKeepTippingTowardThatVIXSpikeSchaeffer'sInvestmentResearch

THE SCALES KEEP TIPPING TOWARD THAT VIX SPIKE

The weekly trendline we're watching for the S&P 500 could act as support on a pullback

Stocks quoted in this article: XIV | VIX | SPY | SPX

2/21/2017 8:21 AM

"... equities have generally responded favorably when the White House is in focus, but have not made notable headway when monetary policy
shifts back into the spotlight... we enter standard options expiration week with the possibility of investors refocusing again on monetary policy, as
they weigh Saturday's remarks by Fed Vice Chair Stanley Fischer to start the week, and then look ahead to Fed Chair Janet Yellen's Tuesday Senate
testimony and Wednesday House testimony ... potential shift to the monetary policy outlook this week comes as the SPY trades just below the
call-heavy 232 strike... from an options perspective, there is little upside beyond the SPY 232 strike in the immediate days ahead... the SPY does
not appear vulnerable to big put open interest strikes acting as magnets, which occurred multiple times throughout 2015 and 2016."
-- Monday Morning Outlook, February 13, 2017

The stock market certainly surpassed my expectations last week, shaking o perceived hawkish Fed comments and blowing through the call-
heavy SPDR S&P 500 ETF Trust (SPY - 235.09) 232 strike discussed as a potential area of short-term resistance. Perhaps momentum traders
jumped in, taking in stride hawkish remarks that were concurrent with better-than expected ination and retail sales data on Tuesday and
Wednesday.

The SPY closing high last week was less than half a point below $235.52, which is 10% above the Tuesday, Nov. 8 Election Day close. In fact, the
SPY high roughly coincides with the S&P 500 Index's (SPX - 2,351.16) 2,350 area, a half-century mark. Moreover, the 2,350 level is 10% above
resistance at 2,135, which marked multiple peaks in 2015.

For those of you who are regular readers of Monday Morning Outlook, you are certainly familiar with past observations I have made regarding
the signicance of half-century marks and round-number percentage gains above and below key levels.

As such, these levels could be a cap in the days ahead. In the past, half-century levels have acted as speed bumps during an ongoing trend, or
obvious pivot levels in terms of support and resistance. These half-century marks are about as important as the more popular century levels,
such as 2,100.

In December, for example, the SPX rst touched 2,250 on the sixth trading day of the month. It cleared that level relatively quickly, but
retested it in mid-December, and again in late December, before nally clearing it for good at the beginning of 2017. In that case, the 2,250
level acted as a magnet for a brief period as the SPX consolidated after a sharp rally.

Since the election, the SPX has run into potential resistance from half-century marks, century marks, and the mid-December 2,270 close prior
to the Fed raising rates and boosting interest rate projections for this year. There have been brief consolidations and small pullbacks along the
way, but the SPX 6-week (30-day) moving average has not been broken on a closing basis. This trendline is currently sitting at the round 2,300
century mark -- a potential level of support, if a pullback occurs.

"Also of interest is CBOE Volatility Index (VIX - 10.85) futures call open interest, which -- at 7.1 million contracts -- comes into this week at its
highest level since August 2015. But on Wednesday morning, more than 3 million of those calls, or 45%, are set to expire. As I said last month, it is
usually after a huge number of VIX calls expire that we are most vulnerable to a volatility pop, and volatility pops usually occur in the realm of
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market weakness."
-- Monday Morning Outlook, February 13, 2017

ToddSalamone Follow
@toddsalamone

$VIXsettlement($VRO)is12.25...3.23millionFeb.$VIXcall
contractsexpireworthless,or95.5%.$SPX$SPY
12:05PM15Feb2017

4 1

"... investors in volatility are nally getting fed up with losses and abandoning their positions... 'It looks like investors might be tiring a bit,' said
Rocky Fishman, an equity derivatives strategist at Deutsche Bank AG in New York. 'In the past, when the VIX was irting near low levels, people
were a bit more optimistic on some type of VIX rebound, so they bought additional shares to maintain their position sizes.'"
-- Bloomberg, February 14, 2017

"... the mellow mood on Wall Street appears to be a reection that the market and the economy have hit a sweet spot that has divorced itself
from the political chaos, and the lack of volatility is justied."
-- CNBC.com, February 16, 2017

With the SPX continuing to display impressive momentum since last month's inauguration, but possibly running into a short-term resistance
area, the elevated risk of a volatility surge remains on our radar -- especially with tax reform in the forefront, with details expected by the
White House to be forthcoming in the rst half of March.

A volatility benchmark that we follow, the VelocityShares Daily Inverse VIX Short-Term ETN (XIV - 66.54), comes into the week between 65 and
70 -- an area that could prove pivotal. Essentially, when the CBOE Volatility Index (VIX - 11.49) moves lower, this ETN will advance, and vice
versa. And last week, XIV burst above the 66 level -- double its November low -- but pulled back fairly rapidly from Wednesday's peak just shy
of 70.

In September and October, XIV peaked in the 40 area, which is double the June 2016 closing low. The September and October XIV peaks in the
40 area were also 50% above the 2015 close. The XIV's peak close at 69.81 last week is 50% above its 2016 close of 46.75, which makes the
action in this ETN much like that when it peaked in September and October last year.

The jury is out as to whether a short-term XIV peak is in, which would imply a simultaneous volatility advance amid lower stock prices. But
given the discussion above, together with other factors -- such as the recent record short position among large speculators in VIX futures (a
group that has been historically wrong at key turning points in volatility during the past few years) -- a volatility pop would not be a huge
surprise.

Furthermore, as I discussed with Bernie Schaeer last week, anecdotal sentiment suggests that more market analysts than usual appear to be
accepting (and to a certain extent, even explaining away) the low-volatility environment. Usually, low-volatility environments breed fear that
higher volatility is just around the corner. These fears are eventually proven correct, but the timing is usually o. Now that many market-
watchers seem to "accept" lower volatility, might they get caught at-footed on a VIX spike?

Finally, more than 3 million VIX call contracts expired last week, and it's just after a boatload of VIX calls expire that risk of a volatility pop
increases. But even if we don't get a pullback, we could see XIV bounce between 65 and 70 as the SPX chops around that 2,350 level.

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My advice this week is the same as last week: Given the increased risk of a volatility surge amid political uncertainties both here and overseas,
but an unwillingness to ght the equity trend higher, consider the purchase of in-the-money call options as a "stock replacement" strategy. In
other words, for every 100 shares of stock that you sell, you purchase one in-the-money call option on that underlying. In this manner, you can
still participate in a continued trend higher, while at the same time decreasing your dollars at risk.

I will add that with many companies already reporting earnings, implied volatilities on options are relatively low again. This means you can
purchase puts cheaply on individual equities or exchange-traded funds as a hedge to long positions -- or as a speculative play, in lieu of
shorting and incurring the theoretically unlimited risk.

Continuereading:

Indicator of the Week: Time to Buy Presidents Day Puts?

The Week Ahead: Retail Earnings, Fed Minutes Dominate Short Trading Week

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Article by
Todd Salamone

2017 Schaeer's Investment Research, Inc.

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