Will S&P500 Confirm Its Breakout?

S&P500 Breakout Last Week and Low VIX

The S&P500 Index (SPX) finally got through the 1360-1380 resistance area and even closed above 1400 on both Thursday and Friday. VIX (CBOE Volatility Index) ended the week at yet another 2012 record low at 14.47 – needless to say, SPX realized volatility has remained much lower than implied volatility that the VIX measures.

S&P500 Index

S&P500 Index, last 2 weeks, 45 minute bars

VIX (CBOE Volatility Index)

VIX (CBOE Volatility Index), last 2 weeks, 45 minute bars

VIX Futures Curve

VIX Futures Curve

VIX Expiration and Record Second-First Futures Month Difference

This week, VIX March 2012 futures and options will expire (the last trading day is Tuesday).

During the last week I dedicated much attention to the relationship between spot VIX and VIX futures and the shape of VIX futures curve, which has been in a record steep contango for most of 2012. I published an analysis of the relationship between the steepness of VIX futures curve and time to expiration. One of the observations was that the difference between the first and the second VIX futures month tends to be greatest near the first month’s expiration, as the first futures month converges to spot VIX.

Market’s action at the end of the week has provided a great example, as March 2012 VIX futures (now with only 2 trading days left to expiration) significantly underperformed April and more distant months. We have even seen a new record on the second-first VIX futures month difference: It was 5.45 VIX points on Friday (16.15 and 21.60). The previous record was 5.10 on 17 August 2010. Maybe we will see even greater difference in the last two days that remain for the March contract.

Macro Data and Fundamentals This Week

The upcoming week will be relatively lighter on US macro data, but we will see some housing indicators coming out. Outside the US there will be CPI in the UK (Tuesday) and in Canada (Friday), German PPI (Tuesday), German and Eurozone PMI (Thursday), and Bank of England MPC Minutes will be released on Wednesday (the rate decision of 8 March).

Although we are way past the earnings season’s end, there will be some major companies reporting this week – among them Adobe (ADBE), FedEx (FDX), and Nike (NKE).

So What Will S&P500 Do Next?

One of the main themes of the week ahead will be whether the S&P500 will confirm its upside breakout and manage to stay above 1370-1380. Three things can happen now:

  • SPX will keep on rising beyond 1400 and won’t look back any time soon.
  • SPX will return to the previous resistance around 1370 and make it a support.
  • SPX will return to the previous levels and fall further. Next support levels on the downside are around 1340 and around 1300.

Of course noone knows which of these scenarios will eventually materialize – plus there are lots of possible sub-scenarios and paths within each of them.

VIX Can’t Predict S&P500 Direction

Contrary to what you can sometimes hear or read, the current VIX level and the current shape of VIX futures curve give us no meaningful clue regarding future direction of equities. They only tell us that:

  • Investors (market as a whole) expect realized volatility to increase in the next 30 days – or at least they are willing to pay premium for being long volatility (spot VIX higher than realized volatility).
  • They expect realized volatility to increase even more in the months to follow (VIX futures curve contango) – or to be more precise, they expect future expectations of realized volatility (= future implied volatility) to increase relative to the current level.

Also keep in mind that:

  • Volatility is non-directional. Although the most memorable volatility spikes occur when the market falls, volatility can also increase by large up moves (note that the largest day-to-day change on SPX in 2012 so far was up: +1.8% last Tuesday).
  • The current realized volatility (as measured over the last few weeks or months) is very low compared to a longer recent period (like 2007-2012), but not really extremely low compared to an even longer time horizon (2003-2012).