Is VIX the Clue to the Market Right Now?

06/13/2012 12:00 pm EST

Focus: OPTIONS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

The broad stock market has been in a relatively tight trading range since early April. There have been some quite volatile days of late, but all within the confines of the trading range. This can be seen via the Standard and Poors 500 Index (SPX). After SPX broke down through 1390 over a week ago, it had one swift move downward, but since then the market has swung back and forth on an almost daily basis. Many of these moves occur without seemingly much logic behind them. In fact, the CBOE’s Volatility Index (VIX) might offer the best clues as to how to view market direction.

Volatility indices (VIX and VXO) have not responded with roaring enthusiasm to recent rally attempts nor to sell-offs either, for that matter. $VIX has been hovering within the 17-21 trading range in recent weeks. As long as VIX is in this range, I would expect the market to be quite volatile, but probably without much definitive direction. A breakout over 21 by $VIX, however, would be quite bearish for stocks. Conversely, a break down below 17 by $VIX would be bullish for stocks. This is the guideline that I was referring to when I said earlier that VIX might a good guideline for market direction. In other words, despite the market’s volatile one-day moves, if VIX is still within the 17-21 range, I wouldn’t chase those moves. But if VIX breaks out, then so should the stock market.

So what does this mean, in stock market terms? The SPX chart still shows heavy resistance at 1390. On the downside, the major support is at 1340. For the first time, that level is below the major bull market trend line that defines this bull market over the last six months or so. Therefore, if that 1340 level is tested, it will be an extremely important test, for that will mean that the trend line is being broken as well. It might well be the case that 1340 will hold and thus there would be a new bull market trend line at a lesser slope, but if 1340 were to give way, a much more bearish scenario would unfold.

In summary, SPX is bouncing back and forth between support at the trend line and resistance at 1390. It is suggested that one observe VIX as a clue to which direction the market might take on a breakout.
           
Lawrence G. McMillan,
President, McMillan Analysis Corp.
www.optionstrategist.com
800/724-1817

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