The VIX Says January May Not Bring Joy for the S&P500

On December 6th, I published an article outlining how the Volatility Index (VIX) was at yearly lows. Due to its nature of mean reversion and how a higher VIX reading points to a lower S&P 500 (NYSEARCA:SPY)(SP500) level, it clearly showed there’d be no Santa Claus rally. And when it was all said and done, the S&P 500 had a -6% return for the month. Worst of all, December was only in the green two days during the month, with an anemic 0.34% month-to-date return on both days. But when I wrote that early December article, I expected the VIX to exit the year at higher levels. But the bad news doesn’t appear to have stayed in December as the VIX didn’t settle materially off its lows on the last trading day of December. This leads me to expect the New Year is catching a case of the 2022s.

For those looking to catch a reprieve in 2023, you might be waiting beyond the first few weeks and perhaps the entire month of January. During December, the VIX never moved to its mean of 26. Instead, it topped out at 25.84 and quickly returned to yearly lows near 20, ending the month at 21.67. In the end, it only had a net gain of 0.84 points or 4% by the time the month and year closed out. I had expected something closer to a 26% return for the VIX.

Not only did Santa not come and deliver presents to the market, but he may have entirely abandoned the cheer and joy he brings.

As you can imagine, the selloff in the S&P 500 in December wasn’t surprising to me. After all, I called it within the first week of the month. But what I didn’t expect was the VIX to enter 2023 near December’s lows. With the same setup two months in a row, it positions market participants for an ominous start to 2023 after investors would like to leave behind the worst year since 2008 (and 2002 before that).

Comparing December’s Notes

Let’s recap where we were at the beginning of December.

December 2nd marked the bottom and the third return to the same level in a year. It isn’t hard to guess what happened to the S&P in the following 30 days in each of those times.

Yup, you guessed right – it falls. The S&P 500 index returned -10.2%, -2.7%, and -6.1% 30 days after the VIX bottomed. In each of the first two times, the VIX went on to peak at 35 or slightly higher. The returns from the VIX’s bottom to peak for the S&P were more startling. They were -11.7% and -12.4%. It took 34 days for the first move and 47 days for the second.

December’s VIX cycle is on its 32nd day, leading to the S&P falling 5.9%. Based on the fact it didn’t get to 26 or above (and under 22 at the end of the year) and the time still possible for it to play out, it doesn’t give me a lot of reassurance the S&P 500 will make for a very green January.

After the FOMC meeting on December 14th, the S&P hasn’t even had a relief rally. The fact the VIX didn’t bounce and either overshoot or maintain its 26 average during this is unsettling. It, therefore, sets up another December-like market move.

The worst part is, this is the most sideways after bottoming the VIX has gotten – prolonging any rally.

The sideways movement concerns me as it could change and make a very sharp and sudden move to 26 – or even 35, as it had the last two times – or it could be a protracted, grinding selloff that lasts for another four weeks or more. In the first scenario, the pain will be fierce but quick, allowing investors to find a bottom sooner. In the latter, the pain will be a dull but painstakingly long process.

Capitalizing On The Data

For traders, either situation could be welcomed, though a hard and fast move would benefit them more. I’ve been setting up options trades using the SPY and sharing them with Tech Cache members. In December, my Jan 20th $365 and $360 puts worked well and sometimes wildly profited within just a day or two, typically as the VIX accelerated upward. Since then, though, it’s been difficult to find a near-term direction for the S&P.

However, things get more direct should the S&P 500 break below 3,800. A break of this support level would send the S&P lower well into the New Year. Combined with the VIX needing to head higher to finish off this low bounce, the setup appears to have a high confidence level. I plan to go long SPY out-of-the-money puts for either Jan 20th or February-dated expiration if the breakdown occurs – which could be as soon as Tuesday or sometimes this week. I’m leaning toward February expirations as I like to be a month out, even if the move occurs two or three weeks ahead of it.

Another Tool To Guide

Considering the lows the VIX found itself leading into 2023, a similar story to December could be underway, leading me to have confidence the S&P 500 is not done selling off. So while the rest of 2023 might have a greener journey, the beginning of it appears to want to pick up where 2022 left off. However, one doesn’t need to take the punches. By hedging with calculated puts on the SPY, one can limit the damage and put the profits to work later for a rebound.

Just remember, the VIX is only another tool in the toolbox. Looking at the S&P 500 and its support levels, combined with other indicators, will create a complete picture to work off of. But, the VIX is an essential tool to align trades around.