Hey Traders,

With the market down just over 3.5% between Jan. 26-29, the VIX is over 30.

A 31% VIX means that the S&P 500 would need to move 2% daily to justify the current cost of the options in SPX.

But the run up that led to the VIX into the 30s isn’t even averaging a 1% move per day.

Take a look at how overpriced options really are: 

The white and blue lines are 10 and 20 day historical volatility (HV), respectively.

While they have picked up a touch, 10 day HV is still barely 20%.

Before the selloff, the VIX was 23, so it was already pretty darn fairly priced, as the VIX typically trades at a 2-4% premium to realized volatility. 

What’s going on here?

The answer is that the VIX is the measure for insurance on movement in the SPX,  because it is based on the prices options are trading at in the S&P 500.

Its costs can go WAY out of whack with how much the S&P 500 is actually moving when there is heavy option demand …

And this almost always happens when there is a systemic event, that Wall Street isn’t sure how to manage.

It also can blow higher when there is fear of a liquidity issue on the Street.

While we love saying Robinhood was out “screwing the little guy” by shutting down trading, what was happening is that Robinhood was (and is) having liquidity problems based on the time it takes stocks to settle.

There are also large hedge funds with liquidity problems …

Other funds, seeing Melvin Capital blow up, are probably deleveraging their books.

This is going to cause the VIX to blow higher…

Even if the market doesn’t move.

The VIX, then, is INCREDIBLY overpriced … but it is overpriced for a reason.

It’s the one asset that is TRULY not correlated to any of the areas where there is risk …

You can’t hide in bonds, you can’t hide in dollars, you can’t hide in FANG, you can’t hide in commodities.

But when you’re scared … the VIX is always a great hiding place…. A place where if the market goes to hell you KNOW you will make money.

And that’s why it went to 37, despite the S&P 500 not really not doing much.

The Option Pit VIX Light is YELLOW, meaning we are going to see wild movement.

Your Only Option,

Mark Sebastian