The Option Pit VIX Light Is Yellow. Volatility Will Move Wildly.

Hey Traders,

Despite the “huge” selloff over the last four days, something surprising has happened.

This unusual occurrence means one of two things …

Here is what I think — and what I am doing about it.

The VIX closed on Thursday at a lofty 21.67, up 0.1 …

That was in spite of the S&P 500 (S&P 500) closing higher.

The VIX has been completely off to the races since Tuesday:

VIX is up about 5.50 points since Monday’s close …

A clear sign of aggressive hedging in both the futures and the options.

But here is the crazy thing …

The S&P 500 is totally disconnected from VIX right now.

10-day historical volatility (HV, the white line) and 20-day HV (the blue line) — measures of how much the S&P 500 has actually moved — has not broken 10! 

That is right, the VIX — which measures implied volatility — is priced at about TRIPLE the actual realized volatility from the last 10 days (which includes this week, obviously), and about 2.6X the 20-day!

ATR (Average True Range), a measure of daily movement in the SPX, is certainly higher, but even that does not account for the VIX’s current level.

ATR is about 32. That would be 0.75% of SPX, give or take …

That indicates a VIX of 12, not 22!

With some risk premium thrown in I can MAYBE get the VIX to 17 … that’s it.

Things cannot stand as they are for long.

One of two things has to happen:

1. 1. 1. The hedgers are right, and this market folds like a deck of cards. This would cause historical volatility to catch up with VIX … that could happen.
         
      2. This market is incredibly hedged, and the hedging feedback loop kicks in.

What is the Hedging Feedback Loop? Glad you asked. Here is the process:

1. 1. 1. I put on a hedge.
      2. The market sells off, and my hedge starts working.
      3. I am not scared because I am hedged, so I do not sell.
      4. With no sellers to buy the dip (BTFD!), the crowd steps in.
      5. Market hits new all time highs.

If that sounds far fetched, look at what has happened with every VIX spike this year.

The point is … the VIX is going to move. 

Probably lower, but certainly in one direction or the other.

I still like the trade I discussed yesterday, but maybe a little flipped around.

I would be buying September VIX puts at the 17 or 18 strike, and hedging off some of the upside risk with a VIX call spread or butterfly.

I’ll also be making trades in my Volatility Edge program. Not only do members receive daily VIX Traffic Light updates, but there’s weekly live content, trade recommendations, and access to Volatility Edge exclusive educational content.

Volatility Edge trades pack a serious punch in normal times, and with the volatility we’re seeing lately, plus factors like the Fed, Delta variant, supply chain issues, geopolitical turmoil … all I can say is … buckle up and get ready to ride it!

And given the current state of the VIX/world, I’m offering a four-month membership at a huge discount (and a huge bonus!) to current Option Pit subscribers.

But I’m only keeping it open for this weekend only, so make your move now! Click here for the details.

Here is the good news that I am 100% certain of …

We will know which of the two choices above (hedgers vs hedging feedback loop) is coming next in the next few days.

I’ll be prepared to trade it either way.

Your Only Option,

Mark Sebastian