T2108 Update – Rally Or Regress: A Fed-Inspired Binary Trade

T2108 Status: 15.8%
T2107 Status: 15.7%
VIX Status: 22.5
General (Short-term) Trading Call: bullish
Active T2108 periods: Day #13 under 20%, Day #16 under 30%, Day #32 under 40%, Day #36 below 50%, Day #51 under 60%, Day #392 under 70%

Commentary
Will the U.S. Federal Reserve deploy its typical forces of anti-volatility? Or will the Fed put on some blinders to the ugliness in financial markets and charge forward with talk of rate hikes and policy normalization?

In the first case, the Fed acknowledges and defers to the market’s on-going push-out for the next rate hike. The odds are now borderline for a July rate hike at 51.5%. I added September given it is now the first month with significant odds for the next rate hike.

The market is now pushing out the next rate hike as far out as September.

Source: CME Group FedWatch

If the Fed hints it is fine with the current set of market expectations, I fully expect a major sigh of relief that could create a rally strong enough to put a quick end to the current oversold period. T2108, the percentage of stocks trading above their respective 40-day moving averages (DMAs) closed the day at 15.8% – just under 5 percentage points away from the 20% oversold threshold.

A Fed-inspired sigh of relief should at least grease the skids for a volatility index that is finally cooling off a bit. The VIX is still holding onto support at its uptrending 20DMA, but it looks ready to take the next step lower given Tuesday’s (January 26, 2016) decline.

The volatility index is still holding up after last week’s major fades at resistance and subsequent gap down.

I positioned for Fed relief by purchasing a fresh tranche of put options on ProShares Ultra VIX Short-Term Futures (UVXY) expiring this Friday. This position is pitted against a second round of shorting a Feb put option as a hedge on future volatility. The chart below compares the current period to the same period a year ago. Note how August, 2014 led to an extended period of an elevated UVXY. It did not resume its “natural” downtrend until late February, 2015. The large surge in trading volume is partly a result of the lower share price and partly a result of the heightened fear in the market.