When to Buy Stocks After the Sell-Off

The one question every investor wants answered after yesterday's 317-point sell-off in the Dow Jones Industrial Average, the largest one-day drop in seven months: Do you buy today?

One clue may lie in the options markets. The Chicago Board Options Exchange created the CBOE Volatility Index (VIX) to "reflect a market estimate of future volatility, based on the weighted average of the implied volatilities for a wide range of strikes." It represents the single most significant input in the Black-Scholes options pricing model used to calculate options prices.

Higher implied volatility generates higher options prices, and yesterday, volatility spiked.


Assuming investors would rush to buy puts as insurance for long stock positions, options traders raised their volatility assumptions. They wanted to sell puts at higher prices -- dare we suggest inflated prices?

Only problem: Investors didn't bite. The CBOE put/call ratio compares total put volume to total call volume as a measure of fear, and yesterday it barely budged.


As market technician Chris Verrone of Strategas Research Partners explained on Surveillance this morning, the VIX and the put/call ratio tend to spike in tandem during days of climactic selling. Traders up prices and investors panic. Since only one occurred yesterday, arguably the less revealing of the two, he says calling a market bottom is premature. He'd like to see more evidence of capitulation before deploying new capital into equities.

Chris cites several other technical indicators as well, noting too many stocks are still too far above their long term-averages, and too few stocks are near three-month lows. In addition, he observes the S&P 500 Index is still above trend.


Bottom Line: Chris believes we are still about 3 percent above a buyable entry point. While he does think industrials have become oversold (per yesterday's blog), he doesn't believe the broader market is there yet.

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