Profunds index and sector trading

[was Steve]

Great article on VIX sent to me by Shawn.
steve

Sentiment and other things
>
>by David Nichols
>Lately I've been discussing the classic bear market sentiment patterns that
>are leading me to conclude this market has a big problem. A falling VIX
>together with falling prices is a highly distinctive bearish sentiment
>footprint.
>Invariably at these moments, I get the same type of e-mails, and come
>across
>the same market commentary. The gist is this: "This time it's different. In
>bull markets the VIX can go into the teens, and stay there for months."
>Since I'm getting these same types of letters now, I'm thinking we're
>within
>a week or two of a major top in the markets. This is how it's always
>worked.
>People are quick to believe "this time it's different." It's just human
>nature. And it's one of the primary reasons why the VIX never seems to lose
>its power as a market timing tool. Only a tiny sub-set of market
>participants even know what the VIX is, and of that tiny sub-set only a
>small fraction have enough faith to trust it at important moments.
>It's always best to keep it simple when analyzing the markets. Don't over
>think it. Don't perform convoluted analytical gymnastics to explain away
>things that have very obvious interpretations.
>Sure, this time may indeed be different, and the VIX might go down to 12
>while the Dow soars over 11,000.
>But do you really think so?
>This market is having a hard time even staying over the "home" level of SPX
>876, much less make a run at higher ground. And all the while people get
>more bullish. I'm just not planning on over thinking that one.
>[Image 1]
>Another confusing thing we've seen lately is a relatively high put/call
>ratio while the VIX has been dropping. Theoretically a high put/call ratio
>shows excess bearishness, while a declining VIX shows growing bullishness.
>With such seeming anomalies, again, I don't try to over think it. I see
>this
>as another sign of growing optimism about the market. If the VIX is
>dropping, and there are a lot of puts changing hands, then that means that
>people are in a mood to sell puts , which is a highly bullish strategy.
>Since this might be a little confusing, I'm going to back up and walk you
>through some details about the VIX and the way options trade.
>The VIX is a measurement of the premiums paid for S&P 100 (OEX) options.
>It's a great proxy for the actual supply and demand in the markets, and
>gives an unparalleled insight into how traders feel about stocks.
>Having traded thousands of OEX options in our service over the years, I've
>got lots of first-hand experience in how these contracts trade in the real
>world. In options trading, there are market makers, whose sole job is to
>make you pay more when you're buying, and give you less when you're
>selling.
>It is a ruthless game, played by extremely clever and experienced
>professionals. You never, ever get a break.
>These market makers are absolute masters at pricing options based on supply
>and demand in the market. Whether you are buying or selling options, the
>market makers are always there to take the other side of the trade -- and
>always to their advantage.
>When the VIX is rising, it means people are willing to pay higher premiums
>for puts and calls. There is demand on the buy side, and the market makers
>are only too happy to jack up the price of options into this surge in
>demand. Invariably, such buy-side demand comes when people are fearful of
>the market.
>When the VIX is falling, it means options prices are coming down, and
>premiums are contracting. There is less actual demand in the market to buy
>puts and calls. Such a lack of demand is strongly associated with market
>participants feeling hopeful about the market.
>Yet when the VIX is falling, and the put/call ratio is high -- as it is
>now -- then that strikes me as a very dangerous thing. It can only mean
>that
>people want to sell puts . Selling puts is a very bullish strategy, as you
>are collecting options premium under the notion that the underlying stock
>or
>index is not going to fall below your chosen level.
>Remember, the market makers always make you buy high, and sell low. If the
>VIX is falling, and the put/call ratio is high, it means the market makers
>are selling low . That's not bullish, not by a long stretch.
>Another thing which many are seeing as bullish is the recent surge in long
>positions by commercial traders in the big S&P 500 futures contract. Yet
>there are a few thorns in this rosy data point.
>First off, the commercial traders in the e-mini S&P 500 contract are
>heavily
>net short. So that's a weird divergence. Also -- and more importantly --
>commercial bond traders are net long. Since there is an inverse correlation
>between bonds and equities, this has bearish implications for stock prices.
>I should also point out that these bond commercials have a great track
>record.
>Plus there's a downside to the commercial traders having a lot of long
>exposure. It means that rallies can be met with plenty of supply. I think
>we
>saw this last week, on three separate occasions, when opening gaps were met
>with a barrage of selling in the futures pits.
>[Image 2]
>Could this be commercial traders paring back long positions? Absolutely.
>These traders sell into strength, and buy weakness. That's their game. This
>overhang of long exposure is not going to be a good thing if data points
>don't start coming in bullish.
>There are just lots of confusing sentiment points right now. Some are
>bullish, and some are bearish. But the thing that I can't get past is that
>prices are failing to make upside progress while sentiment is growing more
>and more bullish and complacent.
>This doesn't mean prices have to collapse right away. Tops are often
>rounded, drawn out affairs, with repeated attempts to push higher. We may
>get a few more of these yet.
>But the next BIG move will be to the downside, and that's the one we'll
>want
>to really bet on when the time is right. That time is quickly approaching.
>One last note: I noticed something strange and fascinating on the intraday
>chart off the recent March low. It's tracing out almost an exact
>mirror-image pattern.
>One of my charting packages has a feature called "mirror-image foldback",
>which is shown below. If the pattern is going to continue to hold up, it
>doesn't look good for the markets. Obviously we can't put too much credence
>in such forecasts, but markets do show a tendency to act in symmetrical
>ways
>in terms of price and time.
>[Image 3]
>
>Sentiment Dashboard
>
>by Adam Oliensis
>[Image 4]
>SENTIMENT TANK: The tank drained 3% on Friday to 25% full of negative
>sentiment. The last time the tank was at this low level the market was
>declining from a full-on test of major resistance in the mid 900s. We could
>spurt ahead to that level, but if we do, this market will drain its
>negative
>sentiment fuel down to fumes.
>SHORT-TERM: The hourly gauge is in an advance phase.
>MID-TERM: The mid-term gauge gave us a buy signal rising 4 points to 90% on
>Friday. However the Confidence Diffusion Index (CDI) is still at 0. The
>momentum of sentiment shows a marked increase in bullishness, but PRICE has
>not appreciated as the tank has drained. The increase in bullishness has
>not
>gotten any traction. That bearish divergence has made it hard for the CDI
>to
>confirm the buy signal.
>LONG-TERM: The weekly gauge has given a buy signal with a weekly CDI of 3
>(out of 7). This could turn into something interesting. However, as we've
>discussed lately, there's a high probability that the effort to create the
>weekly buy signal has drained the tank and exhausted the shorter-term
>measures of sentiment.
>BOTTOM LINE: Any short-term rally up to or slightly through resistance is
>likely to exhaust the market's supply of negative sentiment. The market
>will
>likely have to refuel, scare its participants into more bearishness, and
>THEN it could be nice and ripe to confirm the weekly buy signal and walk up
>a wall of some worry.
>BULLarkey