A VIX Light Change?

Hey Traders,


Based on its sub-indicators, the Option Pit VIX Light should be red — meaning I see (or foresee) the VIX heading down and volatility dropping


Almost all of the individual signals that recently went green (caused by the VIX shooting up and vol is spiking) have switched back to red …


Of the four individual indicators that make up the VIX Light (VIX Curve Formation, VIX Correlation, VIX Volatility and VIX Option Implied Volatility), the VIX Curve is definitely red.


As you can see, VIX futures are back in contango, with future prices higher than spot prices …



Cash is below Feb, Feb is below March. The back end of the curve, though, is still a little backward (inclined).


When the VIX is in contango, short VIX, short VXX or short UVXY tend to work well day-in and day-out, which gives us a smooth red signal.


We were red for the last month leading into the sell-off last week. Here’s  what VXX did:



Yes, there was a spike in there, but over that time period, VXX fell from 18.79 to 16.40, a 13% drop.


The SPX and the VIX are DEFINITELY correlating negatively, which is the way I want it to be with the VIX getting SMOKED over Monday and Tuesday’s rally:



When VIX and SPX are negatively correlating on a rally, that means the smart money “believes”  this rally.


And VIX option is falling:



This is another sign that traders are unwinding hedges and no longer panicking.


If VVIX is dropping while the VIX and the SPX are going up, it’s a good thing for short volatility — but not long puts, because the premium drop from VVIX dropping can be worse than the drop in the VIX itself.


One thing that gives me pause is the pace of the VIX futures moves themselves. The February VIX future is still flying around, both up and now down.  


Take a look at 10 day trailing movement in the futures. Notice the way the FEB VIX future has seen a dramatic uptick in movement over the last few days:



If the VIX futures continue to fall tomorrow, but at a slower pace, then that should be enough to trip my light to red.


If the VIX futures plummet, or pop again, it might stay yellow.


Even on a down move, VIX futures moving too fast does not make for a continuous shorting approach ..


It calls for strategic shorting, which is what I do on a yellow light.


One of the reasons I like the simple light system is that it tells me what to do so clearly.  When it’s green, I want to be long VIX. When it’s yellow, I know I’ll be trading up AND down. And when it’s red,  I know I want to lean short volatility.


The light is great for setting up my hedges and for trading within our Volatility Edge product.


An Example Trade from Yesterday

Here is a trade I did yesterday in Volatility Edge.


I set up a bearish play in the VIX options themselves. I bought the 25 put and sold the 23 put for about .80.


Just because the light is yellow, doesn’t mean I wont short …


It just means I am using smaller size and being strategic.


If VIX falls but the light remains yellow, I will either buy calls or take a profit.


The Option VIX Light is Yellow, meaning we are going to see some wild moves in either direction.


Your Only Option,

Mark Sebastian

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