VIX driving force for Bulls - Trading Journal (12.1.20)

Lets start off with a chart between VIX and SPY. Notice how they both are divergent. The lower the VXX the higher SPY goes. VXX is the volatility ETF traders can use to gauge trader sentiment. After the presidential elections the fear was let out of the market where by the VXX declined. The main reason this was the case was because there was too many traders pricing in an increase in VXX, or directly paying a lot in put contracts that was insurance from a SPY fall. Instead after the election the certainty of who was to be president and the vaccines coming to fight off covid allowed the market participants to breath a sigh of relief.

As VXX continues to fall the put premium is being sold off, forcing market makers to purchase SPY shares to stay delta neutral. It basically meant there was buying in the market as the volatility remained subdued. This has no bearing on resembling the real economy but the reality that traders over paid on the short side and the outcome turned out to be not as bad as expected. Heck thinking back now what could be worse than the entire globe coming to a complete standstill to avoid spreading Covid? That was pretty much bleak.

The images above are a summary one fintwit I follow where they mentioned today's oddity in the markets. Where although the markets were up big the underlining VIX futures where starting to get a bid. This data implies that some traders are expecting stock prices may move lower in the future. The closer the VIX are to the front month getting bid the more potential worry there is to a drop in prices. Not exact science but based on markets principals a higher VIX usually means higher volatility in prices.

The front months meaning M1 and M2, current month and 1 month after are in contango, which is bullish for stocks, however months beyond the first two are being bid on so are at higher values. The concern would be as time passes and M1 expires, than M2 becomes M1 and the months after roll forward 1. Issue being that the future months if they stay elevated will imply market participants are expecting more volatility as they bid up put and call contracts on the SPY.

Currently there is an uptick in volatility in the months ahead. This may coincide with reality of the economy. Currently there are covid cases rising across the country that is forcing certain areas to be on lock down again. The unemployment benefits and halted rental evictions expire at the end of the year. The government needs to pass a bill to keep it from shutting down in the middle of Dec. There is also proposal on future stimulus that needs congress to develop and approve to boost the economy. Then there is the transition phase between president Trump and president elect Joe Biden. This is all items only related to United States directly. Does not even go into trade wars with China, and other global conflicts the US has directly and indirect ties to.

I write this is not to post fear or propose short the market, but rather to emphasize that the real reason why markets are higher since the election is mostly because of how the markets functions. Although buyers and sellers has the final say in higher or lower prices the en-bedded mechanisms that is in place within the markets over the year since the pandemic hit is still being felt right now. It is just more in a positive way on market prices at least for now.

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