The Bottom For Stocks May Be Closer Than You Think

From Seeking Alpha
Summary
The S&P 500 continues its direction, trading on shaky ground.

There was a massive bet that the S&P 500 rallies off its lows.

Meanwhile, some traders are betting the VIX falls below 40.

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Stocks continue their route with the S&P 500 continuing to plunge, but perhaps there is finally a light at the end of the tunnel. However, it has been a brutal market to understand, violently whipping around. The S&P 500 has fallen to around the lower end of its historical trading range and is now suggestions a dire scenario. Based on current levels, the S&P 500 is suggesting that earnings collapse in 2020, with little to no rebound in 2021.

However, some traders appear to be betting we at least get a short-term rebound in the S&P 500, potentially even rebounding to around 2,800 by the middle of May. Additionally, some traders also are betting that the VIX drops from it is historical levels.

Earnings Estimates
Currently, my earnings model is suggesting earnings in 2020 of $162.46 per share, with a one standard deviation range of $152.91 to $172.01. In this environment, assuming the lower end of my range, the S&P 500 is trading for around 15.6 times 2020 earnings. For 2021, I’m modeling for earnings of $183.13 per share, with a one standard deviation range of $170.68 to $195.57. It means the S&P 500 is trading for around 14 times 2021 earnings, based on Monday’s closing price of 2,386.

Historically, using a 20 quarter moving average, the one-year forward PE ratio has been at 17.7, with a one standard deviation range of 15.7 to 18.8. It means at the current earnings multiple for 2021, the S&P 500 is trading below that historical range. It could suggest that the S&P 500 is currently oversold at its current levels.

To get the one-year forward PE ratio back to the lower bound at around 15.7, earnings in 2021 would need to fall to $151.97. That’s a decline of about 17.4% for 2021, and roughly $133.57 for 2020, assuming a 12.1% growth rate, which is the current expected growth rate for 2021. It would indicate that 2020 earnings estimates would decline by about 15% vs. 2019 earnings, and a drop of approximately 17.8% from my current forecast.

Betting On A Rebound
It seems some traders are betting it may not be as bad as the market is pricing in at the moment. There was a massive bet made yesterday that the S&P 500 will rebound by options expiration on May 15. The open interest for the 2,650 strike price rose by around 13,818 contracts on March 17. It does not sound like much, but the calls traded on the ask for about $200 per contract and would imply the S&P 500 rises above 2,850 for the trader to break even if holding the calls until expiration. It’s a massive wager, with a dollar value of around $275 million.

Betting Volatility Falls
Additionally, there was a bunch of betting that suggest the VIX index plunges from its current level of around 80 to approximately 38 by expiration on April 15. The 45 puts options saw their open interest rise by roughly 115,000 contracts on March 17. The puts traded on the ask, indicating they were bought for around $6.80 per contract on March 16. This, too, was a substantial wager, with a dollar value of about $78 million.

Also, the 40 puts on the VIX saw their open interest levels rise by around 73,000 contracts on March 17. These puts also traded on the ask, indicating they were bought for roughly, $8.80 per contract, and implies that VIX falls below $31 by the expiration date on May 20. Again, this is a massive wager, with a dollar value of about $65 million.

One can’t understate the size of these three options bet during a period of such wide ranges of volatility, given the implied moves both the VIX and S&P 500 would need to make. Remember, in options, its possible to lose all of the money placed for the contracts.

Technical Rebound
The technical chart also is showing strong signs of improvement with the relative strength index that’s now beginning to trend higher as the index falls. This is known as bullish divergence and suggests that the momentum in the index is slowly turning more optimistic, and should reverse higher in the days and weeks ahead.

The S&P 500 is currently testing a critical level of support at 2,350, which is around the 2018 lows. If this level fails to hold, then the index could fall significantly further to around 2,180. However, if it does prove to be a strong level of support, and reverse as the RSI suggests, the index could be on a path higher, toward a region of resistance at 2,730.

The markets are still in a massive state of uncertainty as it tries to assess the potential economic impact of the coronavirus. However, the recent betting in the options market and technical charts, along with the S&P 500’s valuation, may be the most substantial signs of a short-term bottom we have seen in this process. If it’s not the bottom then we still have much further to fall, so let’s hope a bottom is finally here.

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