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Chart Advisor: Volatility Echoes

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Wednesday, 15th September, 2021

1/ Volatility index elevated as indexes rebound 

2/ Are global investors nervous? 

3/ Traders seeking low-priced entry on Salesforce call options 

4/ The bottom line

1/ Volatility Index Elevated as Indexes Rebound 

The S&P 500 Index (SPX) has been on an incredible run since the pandemic-induced market pullback in March 2020. The index far surpassed its pre-pandemic highs and is up more than 31% in the past twelve months, but you wouldn’t have guessed that if you were looking at option prices alone. Volatility pricing has settled into a new normal.  

The SPX shares an inverse correlation with the Cboe Volatility Index (VIX). Because the VIX is a volatility measure derived from SPX option prices, put option pricing tends to generate a strong influence on the index. When the market is falling, implied volatility tends to rise.

Chart watchers can recognize in the weekly chart below that a bearish divergence is on display (see the darker red lines on the chart). This may offer a signal for market conditions going forward. While markets have rebounded today, the effects of the pandemic still linger and the VIX remains elevated (compare prices against the horizontal red line in the chart).  

The divergence is apparent because the most recent peaks of the VIX have not corresponded with the current upward trend of the SPX. With an inverse correlation, one would expect the VIX to fall as SPX rises, or the SPX to have revisited old lows as the VIX spiked to former highs. Neither is happening. An elevated VIX means that option pricing for SPX is predicting a strong move. This bearish divergence could represent a bit of a warning sign to investors.  

2/ Investors Optimistic on Oracle Despite Miss 

Shares of Oracle (ORCL) traded higher today, as investors continue to digest the enterprise software maker’s fiscal first-quarter earnings report. ORCL reported earnings per share (EPS) of $1.03 and $9.73 billion in revenue. Analysts had forecast $0.97 EPS and $9.77 billion in revenue. The revenue miss was largely responsible for ORCL shares trending lower by 2.8% on Tuesday, the day after the report was released; however, the stock regained some of that ground today.  

The chart below illustrates how ORCL gained 44% since July to outperform State Street’s Technology Sector ETF (XLK). No small feat considering the sector ETF has risen more than 35% in the last year. The post-earnings stock activity could put ORCL more in line with its sector, but even with a revenue miss ORCL is still out in front. 

3/ Traders Seeking Low-Priced Entry on Salesforce Call Options 

The share price of Salesforce.com (CRM) has been on a downward trend since reporting earnings late last month. Share prices have fallen to a below average range, closing below its 20-day moving average as illustrated on the chart below. This share price activity has correlated with option activity, with put option prices at one of the highest points of the last year, while call option pricing has fallen to an average range. 

The put/call ratio has been levelling out over the past five days, and there are nearly 468,000 calls compared to over 440,000 puts in the open interest. So while put option prices remain elevated, traders seem to be buying call options in larger numbers. Despite the recent post-earnings decline, CRM stock has gained 15% year-to-date. CRM stock received a slew of price target upgrades after its earnings announcement, and option traders appear to be positioning themselves for the stock to rise in the near term.  

For Oct. 15, the next monthly option expiration date after this week, the largest number of open interests is on the $260 call. The options with the next highest open interest for Oct. 15 are the $270 and $280 calls. Open interest for these three calls represents 32% of the total open interest for the mid-October expiration.  

4/ The Bottom Line 

Stocks rebounded strongly but did so in a way that left the implied volatility of SPX options at an elevated level. This is creating a bearish divergence between the VIX and the SPX. It may be a warning sign for investors. 

Originally posted on 15th September, 2021

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