The Option Pit VIX Traffic Light is Red: Volatility Is Likely to Drop.
Hey Traders,
After spanning more than a 10-point range during Monday’s wild trading session …
The VIX closed under the 30-handle.
And although the VIX is up slightly on the day so far on Tuesday …
I have changed the Option Pit VIX Traffic Light to red.
Why would I do this, when the VIX is up on the day, and over the 30-handle?
And if volatility is indeed ready to fall … does that mean the market has hit a near-term bottom?
Here is what I am seeing.
First, let’s take a look at the VIX pits.
There is some notable volume crossing the tape so far on Tuesday …
Including this far-out-of-the-money call spread hedge:
Why would a 60/70-strike call spread actually be bearish for vol?
Well, when traders purchase hedges that are far out of the money – like this trade – it is actually a sign that they are less nervous than if they were purchasing near-the-money call spreads.
Think about it … if you think vol is going to drop, are you going to buy expensive, near-the-money, upside hedges?
Or are you going to spend less on “just in case,” further-out-of-the-money hedges?
This is telling me that this trader is preparing for the worst … but does not actually think that “the worst” is likely to come to fruition.
If they thought the VIX was really ready to go higher, they would have spent more on a hedge more likely to make money.
Now here are some more trades out of the VIX pits today …
These sizable put spreads are also bearish for vol, because it shows me that this trader is looking for volatility to drop by February VIX expiration …
So we have Smart Money traders laying down some big bucks betting on a drop in vol …
What else is telling me we could be getting ready to finally see some calmer waters ahead?
I am also looking at the VVIX, the VIX of the VIX …
We have talked recently about VVIX shooting higher, and it has.
But has it finally topped out?
This chart shows me that might be the case …
After climbing as high as 172 on Monday, the index dropped lower into the afternoon …
And it is lower on the day during Tuesday’s trading session.
This indicates that demand for at-the-money hedges is tapering off …
Which may be a sign that volatility has finally topped out.
And if that is the case, we will see the VIX drop …
And when the VIX drops, the S&P 500 (Ticker: SPX) is likely to go up. (Remember, the VIX and SPX are negatively correlated, so when one falls, the other climbs.)
Of course, with the first Federal Reserve meeting of 2022 concluding tomorrow, an unexpected hawkish or dovish tone could send the market flying in either direction.
He’ll discuss the latest word from the Fed, what to expect next, and how to trade it for profits.
Griff is our foremost Fed expert here at Option Pit, and he knows how to trade Fed policy like no one else I’ve ever met.
You can sign up to join him here – it will be well worth the price of admission.
Your Only Option,
Mark Sebastian