The Option Pit VIX Traffic Light Is Yellow: Volatility Is Likely To Move.

Hey Traders,

Earlier this week, we saw our Option Pit VIX Traffic Light switch to yellow …

Indicating we should prepare for volatility to make a big move.

And move it did …

Now, the thing about a yellow light some people forget is that a “big move” does not mean a big move UP …

It means a big move in either direction.

And we saw a big move LOWER from the VIX this week, as volatility

got completely crushed:

As the S&P 500 (Ticker: SPX) managed to steadily rally:

What I am watching right now is the VIX futures curve.

The VIX futures curve went from weeks of backwardation (futures trading lower below spot VIX) back into its usual contango, with futures trading progressively higher over spot VIX.

In fact, as of Friday afternoon, we are in a rather sharp contango:

You’ll see that the contango has been steepening up all week, as VIX has fallen …

However, with VIX falling from over 25 to 21, VIX futures have not come off nearly as much … going from over 25 to just below 24.

So what?

At expiration, VIX futures must equal spot VIX.

As it stands, the April future has quite a ways to fall to equal cash VIX. 

If VIX continues to trend lower, that means the April future will need to fall even further by the time it hits expiration.

It is critical to remember that VIX options are based on VIX futures, not the actual VIX itself …

So right now, the at-the-money option is based on where the April future is trading (23.90), NOT where VIX is trading (21.33).

This opens the door to a number of potential convergence trades …

Right now, I would be watching for cheap puts …

If this vol crush continues over the next few weeks, they could pay off nicely.

Your Only Option,

Mark Sebastian