Beware "Extreme Volatility" Ahead Of Quad-Witching Friday: BMO

It's not just the Fed traders have to worry about this week.

While the market is seemingly only capable of swinging in one direction ever since the election, BMO's technical analyst Russ Visch warns that the coming days could see a spike in volatility ahead of this Friday's quarterly "Quad Witching", i.e., the day in which all four different types of options and futures contracts expire on the same day.

As Visch notes, "historically, quadruple witching weeks tend to be extremely volatile" as large derivative positions are rolled over. Since 1990 the average weekly spread between the high and low for the S&P 500 during December quadruple witching weeks is 2.98%. The technical analyst concedes that while that doesn’t sound like much, it’s nearly twice the 25 year average and using Friday’s closing data would result in a potential range of 2326 on the high side (which would achieve his current upside target of 2303) and 2189 on the low side for the S&P 500 this week.

Among other things noted by Visch, the technician writes that the short and medium-term trend remains bullish for equities accompanied by daily/weekly breadth and momentum oscillators which continue to improve. That said, he warns that the broader market remains "stretched into overbought extremes so don’t be surprised if we see some minor consolidative/corrective action at some point soon" however, he adds that since "we are in the “sweet spot” of the calendar performance-wise, and weakness should be used as an opportunity to accumulate stocks." Of course, just BTFD... if one ever comes.

Finally, as we have discussed over the past two weeks, a notable divergence has emerged in the Advance-Decline line, where the number of advancing stocks has been declining in recent weeks, and remains a concern to the BMO chartist, as it refuses to validate the most recent S&P breakout.

Meanwhile, while stock traders remain largely immune to concerns about what the Fed may do, FX traders and especially USD bulls got caught flatfooted today, when the dollar plunged the most since September as traders squared positions before the Federal Reserve’s meeting this week.

The Bloomberg dollar index fell the most since Sept. 21, setting session lows in the New York afternoon versus euro, pound and yen before Fed begins two-day meeting Tuesday. Traders unwound long-dollar positions after scorching post-election run, and selling may persist in the short-term, according to Toronto- Dominion bank. The dollar also dropped almost 1 percent or more against currencies of commodity exporters including Brazil, South Africa and Mexico.

Monday’s dollar weakness erased last week’s gain, as measured by BBDXY, when hedge funds and other money managers boosted net bullish positions to the highest since January, according to CFTC data

“As we approach year-end and the positioning is long, people are squaring positions,” said Andres Jaime, a foreign-exchange strategist at Barclays Plc in New York. “Nobody wants to do anything until the Fed and inauguration.”

“We expect the correction to persist in the near-term,” says Mark McCormick, North American head of foreign-exchange strategy at TD Bank. “The USD has clearly overshot.”