The Option Pit VIX Light Is Yellow: Volatility Is Going to Move Wildly.

Hey Traders,

Friday was the first ‘inside’ day we have seen in a while.

The VIX was down a touch, as was the SPX.

But that doesn’t mean we’re in the clear.

The VIX is still likely to see a lot of moves over the next week.

That said, there are some things starting to point toward the VIX calming down.

So what’s going on, and what should we look for this week, heading into Memorial Day weekend?

Here’s my outlook for the week.

In case you need a refresher, the Option Pit VIX Light has four main components to it:

• • • The VIX curve: Are we flat, in a contango, or backward?
    • VIX and SPX correlation: How are VIX and SPX moving together?
    • Volatility of VIX: Is VIX movement increasing or decreasing?
    • Volatility of VIX options: What direction are VIX options moving?

Right now, we’re getting some mixed messages, but I’m seeing more of these indicators are turning to red from green.

Let’s start with the VIX curve.

The VIX curve is in a contango (where the VIX futures prices are higher than the VIX cash price), and the contango seems to be steepening:

June futures are trading at a nice spread to cash, and July is well above June, while the rest of the curve is still pretty tight.

But as a whole, this is a red light signal for VIX.

Next, the VIX and SPX correlation though continues to point out that we are in a market of near-term volatility:

As you can see, over the last 5 weeks, SPX is slightly higher, and VIX is significantly higher … This is a green light indicator.

So my two biggest indicators are giving me opposite signals!

Taking the Middle Ground

Looking at VIX volatility, it is flattening:

Which indicates the VIX is calming down …

VVIX — the volatility of VIX options — is showing me kind of the same thing … falling, but still high:

Both of these indicators seem to be calming,  but are still yellow.

We are heading toward a long weekend. As this tends to temper the VIX, I expect to see more of my secondary lights turning red this week.

But … until VIX drops enough to get back into the 16 range, the traffic light will stay yellow.

I see the potential for a gasp or two of selling this week, but there is real potential for a volatility crush on Thursday and Friday.

I will be leaning towards short volatility, looking for a chance to get short, especially as we head toward the ProShares Ultra VIX Short Term Futures ETF (Ticker: UVXY) 10-to-1 reverse split …

Which I will get to on Wednesday …

Your Only Option,

Mark Sebastian