U.S. Equities Seem To Be Topping Once Again

Playing stock market needs patience. Since 2009 the best idea was to hold long positions in stocks. However, since the beginning of 2015 the US stock market seems to be topping. What is more, the chart below shows that big speculators lost an interest in playing stocks even earlier - the open interest on VIX futures started to go down in the middle of 2014: 

Chart 1

                    source: COT Report and Simple Digressions

Note: VIX, a measure of stock prices volatility, together with stock market indices, is one of the most frequently used ways of playing the stock market

As I stated a few times before, any financial instrument, in order to go up, must be supported by increasing optimism among market players. In the case of VIX, this optimism is expressed by two factors:

• the increased number of players opening new positions in VIX futures, resulting in higher open interest (chart 1). 
• the increased net short position on VIX futures, held by speculators (chart 2)

However, if the open interest on VIX goes down and stock prices go up, it means that less players participate in this run. It is often an indication of the incoming correction in stock prices or even the trend reversal.

A dissipating optimism is supported by "Chart 1" - between the middle of 2014 and the end of 2015 the open interest on VIX futures went down from 450 thousand contracts to 250 thousand contracts (red line). Then suddenly, since the beginning of this year we have seen a rapid increase in open interest on VIX futures (an arrow in violet). It looks like the market players started betting on an abrupt  change in stock prices. However the question is - are stocks supposed to go down or up?

To answer this question, look at Chart 2:

Chart 2

         source: COT Report and Simple Digressions

The chart shows a net position on VIX futures, held by big speculators. It looks like now the speculators are betting on higher stock prices - they hold a net short position. And if anybody holds short position on VIX, it means that this player bets on lower VIX readings and higher stock prices because VIX goes opposite to stock prices (when VIX goes down, stock prices go up, basically). 

This net short position plus one of the highest readings in open interest on VIX are, in my opinion, a mixture supporting a bearish thesis on the US stock market. 

As "Chart 2" shows, most recently whenever speculators were holding relatively large net short positions on VIX futures the stock market was poised to go down soon.

Another chart (Chart 3) also supports this thesis. Now a ratio of short to long positions on VIX futures, held by speculators, is standing at around 1.5. Since late 2014 such readings were an indication of a top in the stock market:

Chart 3

                  source: COT Report and Simple Digressions