The Option Pit VIX Traffic Light Is Yellow: Volatility is likely to move wildly.

I received these questions – and variations on them – over the past couple of days:

Mark, the VIX has been in contango for weeks. Why are you still in a yellow light instead of a red?

The VIX is below 20, why are you not in a red light?

Now you may be asking – what is the Option Pit Vix Traffic Light?

Well, it’s a daily, color-coded volatility trading indicator that I developed over the past 20 years.

Here’s how it works to inform trading …

• Red: The market is falling or staying stable. You can create a trading system and run your normal risk approaches. For instance, the light will be red during a contango market (that’s when the forward price is higher than the spot price — not a lot of worry in the market!).

• Yellow: The market could go either way. Not the best time for normal investing. Tap the brakes.

• Green: It’s time to be hedged up and ready for ugliness – and opportunity. As an example, the light will be green during backwardation. (That happens when the forward price is lower than the spot price. Fear is in the air!)

So all the questions above are good – especially on a day like Tuesday when the market did NOTHING and the VIX got crushed. The SPX closed down 2.86 points and VIX closed at 19.38.

The short answer is the movement in the SPX.

This is a six-month chart of SPX realized volatility vs. implied:

Is there a period where realized has been below implied for more than a couple of days?

No!

For a green light, we need to see realized fall below implied for several days … and it simply is not happening.

WIth MSFT reporting on Tuesday night there is a chance, If MSFT can pull off a rally and pull the market with it, the trend that started on Tuesday could stick.

But if it doesn’t … I want to own premium.

When I want to own premium the light cannot be green, because the light tells us to go long or short volatility.

With SPX movement, there is no conclusion to be made.

So what does a trader do?

I still think that vol will drop in the long term.

But short term, while I want to own strangles, the light remains yellow.

So how do you play it?

Join the Trading Desk and you’ll learn how to play wild near term volatility while the long term looks like it is going to drop.

Your Only Option,

Mark Sebastian