Investors and traders alike are heading into the long weekend with a variety
of potential risks facing them. The media has made us aware of the situation
that is going on in Syria and that the United States may be planning a military
strike.
Since the current Syrian situation arose, we have seen some strong volatility
return to U.S. financial markets. The observed volatility has included both
realized volatility and implied volatility in many of the various option chains.
There are pundits who will surmise a variety of outcomes, but frankly no one
knows for sure. Will oil prices spike if military action occurs in Syria? Will
oil prices fall on a military action(s)? What will happen to gold? What will
happen to risk assets? Will they find Jimmy Hoffa?
I have recently received several emails asking these questions. I have answered
them all in the same manner. I have no idea what is going to happen in financial
markets for sure. Anyone who says they do does not respect the randomness of
markets. We can look at option based probabilities for some clues, but there
is no definitive answer.
Instead I want to look at a very powerful tool that is available on most trading
software platforms. Volume by price is a powerful tool to determine where key
levels are in an index or price chart. The S&P 500 Index is shown below.
As can clearly be seen above, the obvious price points where we saw the most
volume trade are highlighted. If price breaks below the current support level
the 1,580 - 1,600 support zone is likely going to act as a magnet for price
action.
Currently I think there is a high probability that we at least test the 1,600
price level in the next few weeks. The current probability that the 1,600 price
level will be at least touched before the September SPX option expiration (expire
in 20 days) is around 65% on Friday morning. The probability that the SPX touches
1,600 before the October SPX option expiration (48 days) is over 76%.
Clearly the implied volatility in the SPX option chain is telling us that
odds are greater than 50% that prices work below the current support level
over the next 3 - 7 weeks. Additionally we have strong volume by price data
that indicates that the 1,580 - 1,600 price level will act as support.
I do not believe that making
predictions is a great way to trade, but I think assumptions based on
obvious support / resistance level as well as implied volatility based probability
assumptions keep traders from making just pure guesses based on very little
facts.
Back on August 16th I displayed the following chart in an article that was
titled "Will
1,650 Offer Buying Support for the SP500?"
Unlike many market prognosticators, I will tell readers when I was wrong,
when I was right, and when I was close. On August 16th I called for a bottom
to play out around 1,650 and I was close. The bottom was actually formed intraday
on August 21st. The forthcoming bounce rallied roughly 30 points before reversing
back to the downside to our next support level around 1,630.
Ultimately we have the long weekend ahead and with Syria remaining in the
forefront and the United States government fiscal debate looming down the road,
markets could become quite volatile over the next 6 - 8 weeks. Traders need
to act accordingly and manage risk through appropriate position sizing. Market
conditions could get very interesting in the near future.
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