The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop.

Hey Traders,

The Nasdaq-100 (Ticker: NDX) has been lethargic over the last few days.

Almost all the mega cap stocks have been sick since they reported earrings.

• • • Amazon (Ticker: AMZN) is in an absolute free fall.
    • Apple (Ticker: AAPL) can’t catch a lift.
    • Advanced Micro Devices (Ticker: AMD) and Microsoft (Ticker: MSFT) … ouch and double-ouch!

Only Google (Ticker: GOOGL) and Facebook (Ticker: FB) seem to be getting out unscathed so far.

So when will this end? Is there upside in the near future?

Or is the NDX going to stop the S&P 500 (Ticker: SPX) from a rally on the “recovery trade?”

The answer lies in skew.

Skew Know What I Mean?

Skew is the relationship between out-of-the-money puts and out-of-the-money calls, relative to at-the-money implied volatility.

Got that?

Lucky for us, we have two indexes that can help us focus in on EXACTLY what skew is doing.

First, VOLQ is the at-the-money volatility index for QQQ, an exchange traded fund (ETF) that tracks NDX.

VOLQ tracks what eight strikes around the money are trading at from a volatility perspective.

The CBOE Nasdaq Volatility Index (Ticker: VXN), on the other hand, is the VIX of the NDX (which is the index form of QQQ).

So VXN doesn’t just look at eight strikes — it looks at every strike that has a bid.

I can hone in on exactly what skew looks like by subtracting the values.

When the spread is high, that’s a sign traders are hedging with OTM puts instead of ATM puts.

When the spread is low, it’s the opposite.

Let’s take a look at skew:

When skew is at its lowest, that is almost the exact point where NDX peaked.

Now skew is finally just starting to normalize … a sign that the selling is slowing a touch.

I think we SHOULD see this spread expand further. When it gets to 4 or 4.5, THAT is when I think the selling will subside. (It’s in the 3.25 range now.)

Why?

Because it’s a clear sign that market participants are sufficiently scared enough that they are putting on a bunch of hedges.

The Takeaway

In short, we probably have a few more days of selling — but I think the bloodletting in the NDX is starting to slow.

I’d start to look at QQQ calls, potentially on Wednesday.

The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop.

Your Only Option,

Mark Sebastian