When I heard about the outlines of the deal from the House, I thought the president had made the republicans say “uncle.” I was relatively certain that on Monday morning, if a deal wasn’t already passed, the framework would be set and a deal would be imminent. Now that the president has proven there is no deal he can’t say no to. I think traders are going to be paying the price for not heading the markets history lesson: when it comes to event trading it always pays to wait, and/or take the sure money.
Traders that made long equity trades or short vol trades last Wednesday were given 46 points of upside movement in the S&P and/or five points in the CBOE Volatility Index (VIX). Taking profits into the weekend was the smart trade. Even traders that waited until Thursday morning would have picked up 20-25 S&P points and 2.5 VIX points. With all that money made, being greedy on Friday was the tempting trade, but the foolish trade. History has shown repeatedly that the quick buck should be taken off the table, because things like the breakdown this weekend happen a lot.
The even smarter trade, especially for investors, is to wait. Yes, an investor that buys last Wednesday’s closing price will probably be happy in a year, however, there is no guarantee. Additionally these types of downturns are damaging to the investor’s psyche. For the part time trader/full time investor, systemic events can be a nightmare that is not worth the headache. Put it more simply, buying the S&P before in the midst of an event is like driving from Dallas to El Paso, to save 3% on a car…it probably isn’t worth it.
Looking more closely at VIX itself with a close in the 15’s and the S&P down, I would not be surprised to see the VIX open up near 20. As we get closer and closer to Thursday I think we could see the VIX move toward 30. At the same time, the SPX might not do that much. The S&P is down about 15 handles as I write this. With VIX at 15.5, we might see the VIX up a touch more than a point on that kind of move. With event risk priced in, expect to see a VIX performance that far exceeds that of the SPX….until Friday. Going into Thursday’s close, if no deal is getting done, the VIX will be near 30. Even scarier, it will be appropriately priced for Friday’s open.
A VIX at 30 prices in an SPX move of about 2% a day for the next 30 days. We will not actually move 2% a day through. Likely we will have a few VERY big days in a very short period of time, then things will slow down. If we don’t have a deal on Friday we will have a massive down tick, I could see 5% in a day. Then VIX will be off to the races, pricing in MUCH bigger moves in the near term. VXST will be off the charts. We could be off 10% in no time, for the first time in some time, the market could be lower than Jared Woodard’s SAT score.
If we do get a deal, look for another short term three or four day move of 5% higher similar to Thursday and Friday followed by an utter collapse of VIX. From there, all-time highs.
Let me be clear. Mr. President, you made the other party say uncle now you are supposed to stop twisting their arm and get the deal done. The near-term narrative might flip on you killing your next two years. In the long term the narrative could be that you were president during a downgrade, a default, and a recession and that fight over your presidential library might die down a touch.
By Mark Sebastian