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Buckle Up: More Volatility Ahead for Stock Market

Nick M. Do | E+ | Getty Images

Bigger gyrations could be more the norm for stocks in the next couple of weeks as investors watch fiscal and political developments in Washington and Europe.

Stocks rose Tuesday, but were also volatile, with the S&P 500 trading between 1485 and 1498. The S&P ended the day up 9 at 1496, and the Dow was up 115 at 13,900, after plunging 216 points Monday. The Nasdaq was up 13 at 3129. Tuesday's gains came on the back of positive earnings news from Home Depot and stronger housing data, contrasting with Monday's steep decline on worries about the unclear outcome of the Italian election.

The market volatility comes after several weeks of quiet trading where there were few days with big market moves.

"We've gone from the 'too far, too fast' that paralyzed investors on the bullish and the bearish side. Now we've reinvigorated them. Both players are back in the game," said Art Hogan of Lazard Capital Markets. The S&P lost 1.8 percent Monday, its biggest one-day drop since November. Hogan said the shorts have returned. "At 1540 in the S&P, you're too afraid to put a short on, but if it breaks 1500 you put it on with both hands because you see that support level broken."

(Read More: US Bank Industry Earnings Highest Since 2006: FDIC)

Hogan said he expects volatility to persist for the time being. "The Italian issue is going to be with us for weeks," Hogan said "It's unfortunate. In one fell swoop, Italy has moved Europe back to the front burner."

Patrick Kernan, who trades S&P 500 options at the CBOE, said investors have been hedging for a more volatile market. Kernan said the very dramatic, more than 30 percent jump in the VIX Monday was accompanied by some interesting options trades, that suggested investors were hedging against the "sequester," or automatic spending cuts that begin March 1 unless Congress acts. He also said the positioning he's seeing implies a possible daily move of one percent move either way in the S&P for the next couple of weeks.

When stocks were plunging and the VIX rising Monday, "we saw people coming in buying end-of-week options that expire this Friday, buying lots and lots of just out of the money put spreads," he said. "It was when S&P futures were trading around 1510, people were buying weekly 1480 to 1500 strike put spreads." That would have implied as much as a two percent move in the S&P 500. The VIX is viewed as a fear index. It reflects market expectations of near-term volatility and is a metric of the out–of-the-money puts and calls at the CBOE.

"Part of what we've seen is longer-dated options buying today. They're still buying protection, going a little further out in time, "Kernan said. "It's definitely implying that we're going to see a little bit of volatility over the next several weeks. Whether it continues beyond that –there's kind of mixed signals on that."

Fed Chairman Ben Bernanke testifies before Congress for a second day Wednesday, and is scheduled to appear before the House Financial Services Committee at 10 a.m. ET. In his Tuesday testimony, he was dovish, re-emphasizing why the Fed is carrying out its extraordinary easing programs and telling the Senate panel the Fed has the tools to unwind its program when needed.

He also encouraged Congress to act to stop the "sequester," or automatic spending cuts that begin March 1 unless Congress acts. "As I've noted and noted again today monetary policy is no panacea, no cure all and we do not have the ability --we can all disagree on how powerful these measures are, and I do think they are effective-- but I don't think that they can offset 1.5 percentage points of fiscal restraint we're seeing this year for example," Bernanke said. "So in terms of the near term recovery, I think there is a sense of which monetary and fiscal policy are working at cross purposes."

(Read More: Sequestration 'Meat Cleaver' Is Irresponsible: Summers)

Bernanke said the problem is spending cuts now could hurt the economy. "I just think that, to some extent, the fiscal-policy decisions being made are mismatched with the timing of the problem," he said. "The problem is a longer-term problem and should be addressed over a longer time frame and in a way that to the extent possible — and perhaps it's not entirely possible — but to the extent possible it does no harm with respect to the ongoing recovery. That's the kind of balance I hope that Congress will consider," he said.

Bernanke was seen as more dovish than the recent Fed minutes, which contained the hawkish voices of members who questioned how long the Fed should carry out its $85 billion in Treasury and mortgage purchases. Hogan said the fact Bernanke did not take on the hawkish comments directly was slightly disappointing to the market.

"When you got to see the headlines of what he was going to say, the market actually went up because there was more bullish headlines than bearish," Hogan said. "Then it went down when he spoke. He was balanced. We don't want balanced. We want the punch bowl."

The bond market moved a little lower on Bernanke's comment, and the 10-year yield was at 1.89 percent late in the day. "It's not that he said anything. It's perhaps that he said nothing that is the stuff people are focusing in on," said David Ader, chief Treasury strategist at CRT Capital. "The market is on high alert for a potential sell off. Everybody's looking for something in Bernanke that he's giving us the heads up that we're going to head the other way" on easing.

"He kept us calm," said Ader. The Treasury market moved dramatically Monday, as investors ran into the safety of bonds, driving the 10-year yield to 1.86 percent from as high as 2.01 percent earlier in the day."I think the market got a little short. Not desperately short. There may be a little upside here with the sequester hanging over us and the March 27 continuing resolution."

(Read More: Bernanke: My Inflation Record at the Fed Is One of the Best)

Many traders believe Washington will let the "sequester" happen, and that the next showdown between Republicans and the White House will be over the continuing resolution to fund the government March 27. "It will take place so gradually," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. LaVorgna said the sequester should impact the economy slightly, taking 0.4 percent off of 2013 GDP.

What to Watch

Besides Bernanke, investors are watching Apple, which holds its shareholders meeting Wednesday at 12 p.m. ET. Apple stock moved higher Tuesday afternoon, amid speculation the company would discuss some way to enhance shareholder value or how to return capital to shareholders.

There is also earnings news from AB InBev, Target, DollarTree, TJX, and NRG Energy before the open. JCPenney reports after the close, asdoes Liberty Media, Groupon, Limited Brands, Monster Beverage, Chicago Bridge and Iron, Continental Resources, Mylan Labs and Whiting Petroleum.

On the data front, durable goods are reported at 8:30 a.m. and pending home sales are at 10 a.m. The Treasury auctions $29 billion in 7-year notes at 1 p.m.

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.