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We're Seeing a Blow Off Top in Silver

If you haven't been paying attention, Silver has been on quite a tear lately.

Here's a daily chart of silver futures:

slv

The chart also has Bollinger Bands, which show us when a market is seeing movement larger than normal.

And for three days in a row now, silver has been above its upper Bollingr Band. That defines a parabolic move, and often it is a blowoff top.

That last candle?

Silver moved from 19.84 and hit a high of 21.22. 7% in a single day.

That in and of itself is interesting, but here's the kicker...

... that entire move happened during a 3-day weekend, not regular trading hours.

When we see a big move like that and it's not during a normal market session, we tend to see yet another attempt of those recent highs. I wouldn't be surprised if it cracked back above 20 this week.

Into any short term strength and I'll be looking to fade it.

Keep in mind, this is a short term trade. If we look at where silver sits on a longer term basis, this is probably the start of a new trend higher.

silver-weekly

Timeframes matter. Short term, I'm bearish and it's worth a look to take the short side.

Yet into any weakness that feels like the bulls giving up, then it's worth a look to start a new longer term position and play for the move into the 27 level.

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Breaking Down the Brexit

During a slow summer trade, Great Britain rocked the markets by voting to leave the eurozone.

The Dow Jones Industrial Average plummeted 800 points.

It looked as though the end of western civilization was upon us.

This harbinger of doom would bring plagues, locusts, rivers of fire...

Cats and dogs living together! Madness!

Yet, all it took was a single week, and we are already back to post-Brexit levels.

dow futures

What the heck happened?

I'm going to lay it all out for you so you can get a better feel for how markets actually work.

Don't Look at The Dow

If all you do is focus on the "big 3," you'll never see the entire picture.

The big 3 are the Dow Jones Industrial Average, the S&P 500, and the Nasdaq 100.

What do they all have in common?

They are all US-based indexes, and the are large cap stocks.

If you had been paying attention at all for the past few months, you would have seen a sustained "risk off" trade going on in stocks.

For example, look at the Russell 2000 index. This is made up of smallcap stocks, which tend to be viewed as riskier instruments as they can move around a lot more.

When the Russell underperforms the S&P 500, it means that there is a "risk off" feel for US stocks.

So while the S&P 500 is within spitting distance of all time highs, the past year's action has not been great for small cap stocks.

rut

Watch Across the Pond

The Brexit news would mainly affect two areas: Britain, and the rest of Europe.

How have those indexes performed over the past few months?

First, let's look at the FTSE 100-- it's like the Dow Jones in Great Britain:

ftse

From the highs from May 2015, the index dropped 22% to the lows put in back in February of 2016. Since then, it's been a choppy mess.

We can also look at Germany for the other side... the DAX is the main index to watch for German stocks:

dax

Same kind of movement as Great Britain... dropping almost 30% off the highs from 2015.

Clearly, the narrative in these markets is different than what we are seeing in the US. While the Dow doesn't look half bad, there has been siginficant technical damage in European markets, even before the Brexit vote took place.

It Was A Known Unknown

Often times when we have an event like the "Brexit," it has a tendency to fade the first move.

And the bigger the hype of the event, the higher the odds that the event will be faded.

The phrase is called "buy the rumour, sell the news."

So we came into June knowing that the Brexit vote was going to happen.

It was all anyone could really talk about.

And if fund managers were scared about the risks, maybe they would park their money into safer stocks and divest out of Europe for a while.

It's possible that the drops we saw in the markets several months ago had already started to price in some of the Brexit risks.

So when everyone is expecting the markets to run lower... it's possible that those investors who were anticipating that are already out before the event, or have hedged their bets. This creates a floor so the market doesn't find followthrough.

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Last year, we were up 60%.

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All we do is trade iron condors, an option trading strategy that gets results as long as the market stays rangebound.

1. No Trading Weeklies

If you sell premium on short term options, you have the ability to earn fast returns.

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If the market moves too fast, you end up getting blown out of the trade with no ability to adjust or manage your risk.

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The market crash in August 2015, and the correction at the beginning of 2016.

A lot of people got hurt by not planning for those kinds of moves.

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You may be trying to pull the last bit of premium out of the position, but what you'll find is that the position will be "stubborn" for that last round of profits and you'll be stuck holding onto the trade.

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The Move In the VIX Doesn't Matter

The way the VIX has acted over the past two weeks is something that I've not seen...

... probably ever.

The VIX has run from a low of 13 and spiked all the way to 21.

vix

Now this move on its own is not too crazy.

In fact, I would consider this par for the course in terms of how volatility acts.

(And yes, I'm typing this on my laptop while watching the final round of the US Open. Golf is on my mind.)

What really sticks out here is the lack of price movement in the SPX.

Normally, price leads the VIX. If the market sells off, investors get scared and buy SPX puts... which drives the VIX higher.

Yet, the market has been absolutely quiet.

 

spx-hv

Sure the market has sold off, but the actual volatility sits under 9%.

As option traders, we want to watch the spread between the expected fear (using the VIX) and the actual fer (using historical volatility).

And the kind of move that we've seen absent ANY kind of true downside... well, I don't think we've seen it before.

It's All About The Brexit

The reason we're seeing such a strong move in the VIX without any kind of big selloff comes down to one thing:

The British referendum to leave the EU.

We are seeing expected fear "spillover" into equity risk premium.

Want to see something really crazy?

Here is a chart of FXB -- it's an etF for the British pound. It tracks the movement in the currency markets.

fxb

The lower chart shows the implied volatility for FXB options... basically the VIX for the currency.

Here's what I know about reading currency vol...

... anything above 15% and there's some serious shenanigans

... anything above 20% and the market's pricing something really ugly

... anything above 25%? It's not unprecedented but you only see it when the market has already crashed or is expecting a crash.

To put this in perspective, FXB vol hasn't been this high since the market crash in 2008.

This is where the "spillover" theme comes into play.

At some point, hedging currency risk gets too expensive to do.

So if you're a trader needing some "risk off" exposure, at some point you make the choice to pick up puts in the S&P 500 market instead of currencies.

That movement ends up building on itself, and all of a sudden the VIX has spiked to 20.

It's Getting Priced In

The bearish thesis here is that the VIX is full of "smart money" traders that are anticpating the collapse of western finance.

Thing is, I know plenty of stupid option traders. And given how saturated the vol markets are, it's very difficult to say that divergences like this are some kind of a big signal.

I am concerned about one thing... it seems when the markets really selloff there's some kind of move in currencies that really shake the markets.

The crash from August 2015? It was from a change in Chinese currency rates.

The pullback in January 2016? Related to the Fed.

The big drop in 2012 was from the "Fiscal Cliff."

And every summer swoon has been from Greece or PIIGS or some other risk out of Europe.

So of course, the Brexit vote could move the markets.

Yet this is something that we would call a "known unknown."

We know that a market moving event is coming, and a ton of people are hedging into the event.

What happens if everyone is hedged? Then the fear in the market disappates and the actual move in the market is lower than what is being priced in.

That's what this feels like right now.

Unlike, say, the Fiscal Cliff in 2012, if we do see a Brexit vote it will end up being a lot of risks drawn out over the course of months. It's not a straight up/down risk, but the market is pricing it in as such.

What's the Next Move

Here's my prediction on how this will play out...

It's very possible for the SPX to continue to selloff, maybe trade back to the lower end of the range.

Yet into any kind of selling, the VIX will not continue to skyrocket.

That's because traders will be using any downside action to take profits on their hedges... and the uncertainty surrounding the Brexit vote will start to get sucked out of the premium in the options market.

After that, we'll go back to the narrative that's dominated the market for a year now-- the "will they won't they" news risk around another Fed rate hike.

Now if I'm wrong... if the Brexit vote comes through and the VIX stays up... that's a bearish signal that the markets are about to break.

How To Profitably Trade The Volatility Markets

My favorite vol related trading instrument is VXX. It's a volatility ETN that perpetually sucks.

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