Is VXX Issuing a Warning?

  • SumoMe

They say that complacency is the enemy of the stock market.  If so, the action of ticker VXX – the exchange-traded fund designed to track the VIX Index – may be of interest. 

The indicator known as “Narrow Range 7”, or NR7 for short was first introduced by Toby Crabel some time back in the 19080’s or 1990’s.  The theory is that when the difference between today’s high price and low price for a given security is the smallest it’s been over the past 7 trading days, that security is said to be “contracting” or “compressing.”  The theory goes that – just as ying follows yang – once the compression is over there should be an “expansion”, – i.e., a meaningful price movement.

Now this is not always necessarily the case – i.e., a security can remain mired in a range for a good long while.  In addition, a simple NR7 gives no indication on its own as to whether the ensuing price expansion will be to the upside or to the downside.    Still, please note the chart in Figure 1.  This extreme compression DOES NOT guarantee or even imply that the stock market is about to decline.  But it sure does seem to signal a whole lot of complacency among investors. NR7

Figure 1 – Ticker VXX has registered seven consecutive days of narrower and narrower ranges (Courtesy: AIQ TradingExpert)

In all candor I am not entirely sure what this means.  My gut tells me that following the whole “shutdown/debt limit” crisis, and with QE2IB (Quantitative Easing to Infinity and Beyond) set to feed liquidity to the market until the end of time, it is pretty much assumed that the stock market has nowhere to go but higher.

Complicating this for me personally is that most of my indicators are bullish, so I am not inclined to pound the table and shout “the end is near!” (although it is kind of fun to see the looks on people’s faces when I do it just for fun.)

Still, it is not a stretch to think that we could be setting up for a nasty surprise in the near-term (i.e., sometime in the next several weeks) which would certainly surprise the heck out of most investors.   People who are inclined to hedge might consider buying VXX December 13 strike price call options (as I write, it is $99 for a 1-lot, with the futures suggesting that stock indexes will open higher, i.e., that VXX will open lower).    vxx-1Figure 2 – VXX December 13 call (Courtesy: ww.OptionsAnalysis.com)vxx-2Figure 3 – VXX December 13 Call (Courtesy: ww.OptionsAnalysis.com)

Summary

Everything – trend-following, seasonal, liquidity – seems to point to a bullish trend in the stock market.  And I am not one to stand in the way.  But historically when everything “looks good” for the stock market, one of two things happens:  Either the stock market:

a)  trends higher based on the bullish confluence of indicators, or,

b) the market surprises the daylights out of the majority with a nasty surprise.

$99 to insure against b seems like a reasonable price to pay.

Jay Kaeppel

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