Home » The Unwind Of A Volatility Trade May Cause Stocks To Fall Further The Week of August 7, 2023

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The Unwind Of A Volatility Trade May Cause Stocks To Fall Further The Week of August 7, 2023

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Stocks were lower last week, creating bearish engulfing patterns on the weekly charts. The most notable was on the S&P 500, which saw the body of the red candle completely overtake the body of the green candle from the week before.

This pattern was also present on the Q

The Dow Jones Industrial Average

and the IWM.

It was also present on the SPY to TLT ratio on the daily chart.

Additionally, this week saw confirmation of the bearish engulfing pattern on the daily chart on July 27.

These are bearish technical signals, and if they are confirmed with another down week suggests that there is probably more downside to this market. But more importantly, this past week, the short implied volatility dispersion trade showed signs of breaking down; we have been tracking this trade in my subscription service, Reading The Markets, for some time.

This is a trade where a fund shorts the S&P 500 at the index level and goes long volatility on the components of the S&P 500 while also going long the underlying stocks. One tool to measure this trade is the one-month implied correlation index, which had a big week, rising to almost 21, after falling to levels not seen since late 2017 and the fall of 2018. This rising index suggests this short volatility trade is most likely in the process of now falling apart.

One reason it is falling apart is that we are seeing rates rise rapidly, and the dollar is regaining momentum. The US dollar to Canadian dollar had a massive move this week and is on the cusp of breaking out and moving to 1.36.

The VIX appears to move with this USDCAD trade, and when the USDCAD rises, the VIX tends to move right along with it.

This was visible and on display on Friday when the USDCAD started to rise around 12:45 PM ET.

Much of this dollar strength is coming from two sources, a better-than-feared US economy, which s causing many analysts to scrap their recession calls, and due to the BOJ raising the cap on the 10-year JGB. Rates in the US have been moving higher right, along with rates rising in Japan.

If this trade continues to unwind, it will mean that the next level of support for the S&P 500 comes at a gap of around 4,440 and then 4,390.

The Qs have now failed two days in a row to get above resistance at $375, which is bearish because that price had previously served as support. This makes the next support level $368 and then $358.

But perhaps the most important of all is Apple’s significant drop last week. The stock fell below an uptrend that had been in place since early January. It was a very well control rally on the way higher, and now that trend is broken. This could be the stock to watch because if Apple doesn’t recover, the entire short-volatility dispersion trade can’t work, leading to the trade unwinding further. Apple’s next big level of support doesn’t come until $175.

Have a good week.


Charts used with the permission of Bloomberg Finance L.P. This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.


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