We’ve been writing for the last month about the risks, and then the corrective activity in the stock market. Even as the market didn’t peak until the first few days of September, it “feels” like this pause has lasted longer than that. And yet, we don’t seem much closer to the end of this period than a few weeks back when it all began. What we mean is that while a few of the outrageous sentiment indicators such as options positioning have moderated a little, we have yet to see the kind of emotional flush/liquidation that is typically associated with good intermediate lows. With that in mind, we highlight here a small number of things we’ll be looking for to help us assess if we are “there yet”.
1. Good intermediate-term lows come with spikes in volatility and hedging activity. So far, volatility as measured by the VIX has actually gone down a bit during this selloff as a result of some unwinding of speculative call option activity that sent implied volatility through the roof in August. Odd as that scenario was, we still would expect a meaningful move back up in volatility as the selloff progresses and larger daily moves in stocks get priced in. Furthermore, good lows are almost universally accompanied by a pick up in downside hedging activity. We can measure said activity using the put/call ratio. It’s still below 1 indicating more calls being bought than puts even as the S&P 500 was down as much as 1.6% on Friday.