Technically Oversold Volatility Index a Short-term Negative for Stocks

Friday represented the third consecutive down day for the Dow Industrials. Historically, when the Dow has posted three straight lower closes during options expiration week, there’s a notable tendency for the downtrend to continue over the next 1-3 days. The last thirty times that the Dow closed lower three days in a row (all during options expiration week) are listed in the table below. Note that in 27 out of 30 cases, or 90% of the time, there was a subsequently lower Dow close within the next three sessions, significantly better than the 67% at-any-time odds for a lower Dow close within three days. The implication is that when the market gets into a trending mode during expiration week, there’s a better than average chance of that trend continuing over the near-term.

Dow Down Three in a Row During Expiration Week
12/19/08… ???
06/18/08… Lower Dow close two sessions later
01/17/08… Lower Dow close one session later
10/17/07… Lower Dow close one session later
08/15/07… Lower Dow close one session later
01/19/07… Lower Dow close one session later
05/18/06… Lower Dow close two sessions later
04/15/05… Lower Dow close one session later
03/17/05… Lower Dow close two sessions later
01/21/05… Lower Dow close one session later
10/14/04… No lower close within three sessions
07/16/04… Lower Dow close one session later
02/20/04… Lower Dow close one session later
10/17/03… Lower Dow close three sessions later
07/17/03… No lower close within three sessions
01/17/03… Lower Dow close one session later
12/19/02… No lower close within three sessions
09/19/02… Lower Dow close two sessions later
06/21/02… Lower Dow close two sessions later
09/19/01… Lower Dow close one session later
08/15/01… Lower Dow close two sessions later
06/15/01… Lower Dow close two sessions later
09/15/00… Lower Dow close one session later
07/19/00… Lower Dow close three sessions later
02/18/00… Lower Dow close three sessions later
01/20/00… Lower Dow close one session later
10/13/99… Lower Dow close two sessions later
09/16/99… Lower Dow close three sessions later
01/13/99… Lower Dow close one session later
08/21/98… Lower Dow close three sessions later
12/19/97… Lower Dow close two sessions later

Volatility fell for the fourth day in a row Friday, sending the VXO under its lower bollinger band on a closing basis. Historically, oversold volatility typically means limited upside potential for stocks over the next 2-3 sessions. Volatility generally won’t remain in oversold territory for more than a couple of sessions before rallying. Given the inverse relationship between volatility and the stock market, rebounding volatility should correspond with a weak market. Listed below are all recent occurrences when the VXO closed under it’s lower band, indicating volatility is technically oversold, along with the performance of the OEX over the next three sessions…

VXO Closes Under its Lower Bollinger Band
12/19/08… OEX ???
05/19/08… OEX -2.5% three sessions later
02/25/08… OEX -0.1% three sessions later
12/21/07… OEX -0.5% three sessions later
09/21/07… OEX +0.1% three sessions later
11/17/06… OEX +0.2% three sessions later
08/16/06… OEX +0.5% three sessions later
11/03/05… OEX +0.1% three sessions later
09/09/05… OEX -1.1% three sessions later
06/21/05… OEX -1.9% three sessions later
04/12/05… OEX -3.2% three sessions later
02/04/05… OEX -0.5% three sessions later
02/01/05… OEX +1.2% three sessions later (*)
12/21/04… OEX +0.1% three sessions later
06/08/04… OEX -1.2% three sessions later
07/25/03… OEX -1.1% three sessions later
05/16/03… OEX -2.2% three sessions later
04/17/03… OEX +3.0% three sessions later (*)
04/14/03… OEX +0.9% three sessions later
11/20/02… OEX +2.1% three sessions later (*)
11/15/02… OEX +0.7% three sessions later (*)
12/27/01… OEX -0.3% three sessions later
12/19/01… OEX -0.6% three sessions later
10/26/01… OEX -4.2% three sessions later
05/21/01… OEX -1.5% three sessions later
01/23/01… OEX -0.4% three sessions later
08/08/00… OEX -0.2% three sessions later
06/29/00… OEX +0.5% three sessions later
11/18/99… OEX -0.4% three sessions later
10/08/99… OEX -3.9% three sessions later
06/04/99… OEX -0.8% three sessions later

Note that in only four cases out of thirty, or 13% of the time, was the OEX up more than 0.5% three days later. That’s significantly worse than the market’s 37% at-any-time odds of gaining more than 0.5% over any three day period.

Categories : Archived EOD Commentary, End-of-Day Commentary

 Print This Post