Options Market Update December 14, 2015

The steady decline in the prices of oil and other commodities, along with the deteriorating state of the credit markets, sent shockwaves through the equity markets last week. The S&P 500 lost 3.79%, the Dow fell by 3.26% and the Nasdaq dropped 4.06%.  

For the bulls, it was a challenging week as the three major indexes were again rejected at recent highs. That said, another mega-merger—Dow Chemical and Dupont—was announced, and the market leaders, which lost some ground, still look to be in decent shape. On Wednesday, the Federal Reserve is likely to finally raise interest rates, which will remove some of the uncertainty the market hates.

For the bears, last week was nearly ideal, as virtually ever sector of the market came under intense selling pressure at some point. The selling pressure began early in the week as oil prices continued to fall, which brought down oil and commodity-related stocks. The selling pressure on oil continued through the week as U.S. crude closed below 36 for the first time since 2009 on Friday. This sent fear through the credit markets, and soon enough the market leaders, which had held up the market, began to come under intense selling pressure as well, and the three major indexes closed at the lows for the week on Friday.


The Chicago Board of Options Exchange Volatility Index (VIX) closed the week at 24.39, higher by 65%. This level of volatility and put buying is not particularly surprising as the credit markets are once again signaling extreme fear.

I expect the VIX to remain above 20 even if the market rallies in the coming days leading up to the Federal Reserve’s decision to raise interest rates on Wednesday. This first rate hike, if it happens, will be the first hike in many years, so no one knows how the market will react in the days that follow.

Events for the Week to Come

Typically I expect the market to be quiet in the days leading up to Wednesday’s Federal Reserve announcement on interest rates. However, because of the market’s volatility and concerns over commodity and credit markets, nothing would shock me in the coming days.

As of Friday, the market is pricing in a better than 80% likelihood of an interest rate hike this week. However, if the markets continue to fall apart in the days leading up to the announcement, the Federal Reserve could have an excuse for not hiking rates. Regardless of a hike or not, the press conference following the rate decision in which the Chairwoman will discuss the committee-s thoughts on the future of rate hikes could cause as much volatility as the decision whether or not to raise rates.

What Traders are Saying

The past week was challenging for the bulls. While the three major indexes all lost well over 3%, the damage was much more severe in many individual stocks. Investors understand why oil stocks would fall with the price of oil. What many don’t understand is why the steady decline in the price of oil would cause selling in stocks such as Amazon or Facebook. The reason is the meltdown in the high yield market.

Many prominent traders such as Carl Icahn, Jeffery Gundlach and Bill Gross had predicted trouble in the high-yield market for the past several months. Late last week, Third Avenue Management, considered by some to be the best in its field, announced a freeze on withdrawals and liquidation from its Focused Credit Fund, which had suffered large losses this year. This prompted Icahn to tweet “The meltdown in High Yield is just beginning.”

When currency, commodity and credit markets experience major issues, traders sell first and ask questions later. It doesn’t matter how many products Amazon is selling or how many users Facebook has … it becomes a race to raise cash any way possible.

I was able to spot these growing issues, so we have extremely light market exposure and didn’t add new positions into the market weakness. That said, unless these credit issues turn into a full blown crisis, I expect the market will stabilize at some point, which has been the case with every “crisis” we’ve seen this year, and I will likely add a new bullish position in the days to come. However, because of the extreme uncertainty in the markets, when I do send the next alert, I recommend keeping your allocation on the lower end of the spectrum.

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