The CBOE Market Volatility Index (VIX) is one of the stock market’s premier sentiment indicators, since it tends to move inversely to the market. At market bottoms (even bottoms that turn out to be only temporary, like a range bottom), the VIX tends to spike above 30, although above 35 is an even better sign. Please refer to my post yesterday for VIX and INDU (Dow industrials) charts, which illustrates the inverse relationship.

High spikes in the VIX tend to signal a market bounce off a support level, and the higher the VIX spike the better (low VIX readings are not very helpful in regard to market tops).

Yesterday, the VIX hit a high of 36.40, the highest reading since January 22nd of this year. Today it has hit 42.16 and is 39.25 as I write this - falling, so far.

Note that 42.16 is the highest level the VIX has hit since October 2002. Thus I think it it signaling a strong market advance off the bottom - which is forming as we speak. Like a farmer with sodden fields, I welcome the sun breaking through the clouds.

By the way, the MACD for the VIX has been climbing for several years and this year finally has risen to 1998 levels, as the following monthly chart shows:

In Dow Theory, simultaneous highs in both the INDU and the Transportation averages (still known to traders as the “rails”) is a bullish confirmation; simultaneous lows a bearish confirmation. The INDU appears to be bottoming, but the rails are up, which in Dow Theory parlance is a non-confirmation, meaning who knows?

But I think the VIX knows, because VIX spikes indicate panic, which is the stimulus point for the market to reverse course - because panic selling grows exhaused and the bottom feeders (like me) start rushing in.

Covered Call Thoughts:
What a great time for covered call writers (and call buyers) to look for trades! The best tactic will be to leg in, meaning buy the stock and wait to write the calls only after a price rise, which really makes returns take off. When you start to feel confidence in a snap-back, it is time to get in. If you can’t quite get a real confidence level, consider buying a long-term protective put (only those that are dirt cheap, with very little time value). When puts start to get cheap, what is that telling you?

If you have good stocks that are seriously down with the market, as opposed to being down on their own, don’t take a panicky loss here. The good ones should snap back.

If on the other hand the stock is Lehman Brothers, Goldman Sachs or AIG, to name just a few that have been wingshot (or gutshot), then a market surge can’t be counted on for much help.

This entry was posted on Thursday, September 18th, 2008 at 1:03 pm and is filed under Markets/Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.