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

Hey Traders,

While this is a vast generalization, there’s a pecking order to traders in the world of equities.

At the top are the Variance and Credit traders.

These are the traders trading complex structured products, debt, and OTC variance swaps.

The next rung in the option traders in indexes – traders managing positions in SPX or NDX.

After that, we have the equity option traders; they are trading AAPL and GOOGL options.

Next come the futures traders, slinging S&P 500 futures.

Finally we have the stock traders.

That’s right, the people that know stocks likely know the least about things.

So what does this insult to many traders have to do with what happened on Thursday?

There’s a big difference between what the equity, option, and variance traders think is going to happen in the next few days.

Based on the price action of the S&P 500, the equity crowd clearly thinks the market is going higher.

That’s the only reason the S&P 500 would go essentially straight up all day on Thursday.

The index option crowd is mostly on board.

The VIX itself got drubbed on Thursday falling to 17.03.

Based on the movement in the S&P 500 relative to volatility they are expecting malaise and slow movement to return:

Then there’s the variance traders – the ones who trade VIX futures.

VIX futures did fall on Thursday, but not like the index itself.

In fact, the spread between the cash and the futures has stayed excessively wide:

The cash index is trading more than 2.4 points below the front month future.

So, either the future has to drop toward 17, or the index needs to rally.

Historically, the VIX futures have been right.

So what should a trader do in this scenario?

Buckle up and buy volatility – the S&P 500, the NDX, and the RUT are going to move hard in the coming days.

Questions about that? Comment below!

Your Only Option,

Mark Sebastian