The Option Pit VIX Light Is Red, And Volatility Is Likely To Drop.

Hey Traders,

We had another day of the VIX up, and the VIX ETP’s down (not that I’m complaining, as I was able to score a solid 24% win on ProShares Ultra VIX Short Term Futures ETF — you can see the trade details here).

But how long will the VIX be able to hold near 17?

Interestingly, Big Money is betting “maybe not long.”

Here is what I am seeing …

VIX managed to eke out a small gain on Tuesday, mostly due to the tanking of the Nasdaq 100 (Ticker: NDX) …

But the VIX ETP’s were down once again, as the VIX futures curve continued to converge toward the spot price of VIX.

But how long will it last?

I told you I am still pretty close to a yellow light …

However, check out the activity that is going on in cheap out-of-the-money puts:

In August, over 12,000 of the 16-strike puts were traded, mostly bought.

In September …

Over 25,000 of the 15-strike puts traded for $0.10, also mostly bought.

In October…

They went after the 14-strike puts, also mostly paying $0.10.

Collectively, that is about 63,000 puts trading, most worth $0.10 or less. To put that into perspective, more than 15% of the total VIX options traded on Tuesday.

And the open interest is creeping higher in those months as well.

Big Money is setting up a stair-step down for volatility, pointing toward a sub-14 VIX in October.

But look at the VIX futures curve:

The August future needs to drop more than 2 points for the 16-strike puts to end up in the money; September, more than 5 points; and October, almost 8 points!

The September 18-strike puts cost $1.10 … they are in-the-money relative to the cash index right now …

And it seems at least some traders out there think we could see a 15 VIX by then…

I think there are some decent odds on long puts in September on the 18-, 17-, and even the 16-strike.

Your Only Option,

Mark Sebastian