Something Shiny That Could Be the Real Thing

The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop.

Hey Traders,


We have a host of amazing traders here at Option Pit …


Among that group is veteran bond trader Bill Griffo and his Power Income letter.


Griff has been saying for months that there is a boatload of inflation heading our way.


And let’s think about the headlines we’re seeing all around today …


Driver shortages, staffing shortages at restaurants, and rising prices in food, lumber, housing, gas and metals …


You name it … and the price is rising!


This has me interested in SPDR Gold Trust (Ticker: GLD).


Gold has traditionally been a major store of wealth when inflation hits the U.S.


While it has yet to react so far, it appears that a breakout is starting form …



Now what really surprised me is where the CBOE Gold Volatility Index (Ticker: GVZ) is trading.

GVZ is the VIX index methodology on GLD options.

Take a look:

While GVZ is getting a bit of a pop today, the index is still
really inexpensive.

This makes me want to buy calls — because the option prices are cheap.

June 170 calls, which are at the money, are glittering at just $3.20. And GLD is up about 2.50 as of this writing.

The Option Pit VIX Light Is Red,
and Volatility Is Likely to Drop.

Your Only Option,

Mark Sebastian

Lots of Movement, But No Change


The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop.


Hey Traders,


Tuesday looked very ugly for a little bit.


      • The VIX was over 21 — and zooming higher.
      • Meanwhile, the S&P 500 was down 60.
      • And VVIX — the volatility of VIX — was booming.


All that — yet no change in my Option Pit VIX Light — the proprietary indicator that guides my volatility trading.


It started to get close to a move, but never made the switch.


The reason why is important for almost all indicators that are supposed to sense a change in trend …


They should not be reactionary.


The VIX traffic light takes into account four sub-indicators:


      • The VIX Curve
      • VIX Correlation
      • VIX Volatility
      • Volatility of VIX options — the aforementioned VVIX 


The traffic light would have 100% turned yellow if we had closed at mid-day


We had a flattened VIX curve, with the cash and the VIX May future pretty much on top of each other.


But by the close ….



That, friends, is contango — futures price higher than the spot price — and it’s a red light for VIX futures (the most important sub-indicator).


Also remember what a red light means …


      • Red: The market is falling or staying stable. You can create a trading system and run your normal risk approaches. For instance, the light will be red during a contango market (that's when the forward price is higher than the spot price — not a lot of worry in the market!).


Now, elsewhere, we had the VVIX skyrocketing. I mean, look at the candle from Tuesday:



At the highs, the VVIX was showing a yellow, or even a green light (which, if that comes, buckle up.)


But where VVIX closed? Still red, although inching toward yellow.


VIX correlation was a little different. This is the one sub-indicator that actually turned yellow and has me on edge.


We are not seeing the VIX sell off much on rallies — but it is launching higher on selloffs.


Since April expiration, SPX is higher and so is the VIX:



If there’s one thing that is concerning — and I think points to the VIX being kind of stuck in a holding pattern — it’s VIX correlation.


I would also note that VIX volatility itself is picking up a touch from the lows, but it’s nowhere near breaking out yet:



The Takeaway


Despite the selloff, at the end of the day, I had three reds and one yellow sub-indicator — that produces an overall red light (but one with a touch of an orange hue to it).


I am putting on a few small hedges here and there, but I am not putting on my major hedging programs.


I am also looking for spots to get short volatility.


Your Only Option,


Mark Sebastian

When Will It All End??

The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop.


Hey Traders,


The Nasdaq-100 (Ticker: NDX) has been lethargic over the last few days.


Almost all the mega cap stocks have been sick since they reported earrings.


      • Amazon (Ticker: AMZN) is in an absolute free fall.
      • Apple (Ticker: AAPL) can’t catch a lift.
      • Advanced Micro Devices (Ticker: AMD) and Microsoft (Ticker: MSFT) … ouch and double-ouch!


Only Google (Ticker: GOOGL) and Facebook (Ticker: FB) seem to be getting out unscathed so far.


So when will this end? Is there upside in the near future?


Or is the NDX going to stop the S&P 500 (Ticker: SPX) from a rally on the “recovery trade?”


The answer lies in skew.


Skew Know What I Mean?


Skew is the relationship between out-of-the-money puts and out-of-the-money calls, relative to at-the-money implied volatility.


Got that?


Lucky for us, we have two indexes that can help us focus in on EXACTLY what skew is doing.


First, VOLQ is the at-the-money volatility index for QQQ, an exchange traded fund (ETF) that tracks NDX.


VOLQ tracks what eight strikes around the money are trading at from a volatility perspective.


The CBOE Nasdaq Volatility Index (Ticker: VXN), on the other hand, is the VIX of the NDX (which is the index form of QQQ).


So VXN doesn’t just look at eight strikes — it looks at every strike that has a bid.


I can hone in on exactly what skew looks like by subtracting the values.


When the spread is high, that’s a sign traders are hedging with OTM puts instead of ATM puts.


When the spread is low, it’s the opposite.


Let’s take a look at skew:



When skew is at its lowest, that is almost the exact point where NDX peaked.


Now skew is finally just starting to normalize … a sign that the selling is slowing a touch.


I think we SHOULD see this spread expand further. When it gets to 4 or 4.5, THAT is when I think the selling will subside. (It’s in the 3.25 range now.)




Because it’s a clear sign that market participants are sufficiently scared enough that they are putting on a bunch of hedges.


The Takeaway


In short, we probably have a few more days of selling — but I think the bloodletting in the NDX is starting to slow.


I’d start to look at QQQ calls, potentially on Wednesday.


The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop.


Your Only Option,


Mark Sebastian

Tracking This Item VERY Closely

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

Hey Traders,

The VIX futures curve remains in a nice contango, with the futures price higher than the spot price.

As you’ll notice below, VIX is trading at a tasty discount to May, the same from May to June and so on. It’s like the TrackMan tracer on PGA Tour golf coverage. You love to see it …

But the tenor seems to have changed a bit over the past couple of days.

And something is afoot that I don’t like …

Notably, take a look at the VIX itself. After falling consistently for two months, the index has stopped in its tracks:

VIX has bounced between 17 and 19 for about two weeks — which is hard on short volatility trades.

More important, to me, is the relationship between VIX and the S&P 500 (Ticker: SPX).

The VIX has been relatively strong as the SPX has climbed, especially since April expiration on the 19th of last month.

Since that time, the S&P is up marginally …  and the VIX is up significantly.

If the VIX was any stronger, the component of my traffic light that takes into account the correlation between SPX and VIX would turn yellow.

This is something I am watching.

While — for now — I continue to lean short volatility, I have certainly dialed back how aggressively I’m trading.

I’m also keeping a tight watch on adding a hedge.

There is a distinct possibility that the market could have a short term rollover and head back to 4,100.

The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop.

Your Only Option,

Mark Sebastian

VIX Truth is Beyond the Headlines

The Option Pit VIX Light is Red, and Volatility Is Likely to Drop.


Hey Traders,


The S&P 500 (Ticker: SPX) had a really nice day on Thursday, closing up 28 points.


But that does not tell the story.


The real news from Thursday is what happened in the middle of the trading day …


The S&P took a mid-day dive and the VIX shot higher.


Take a look …



The VIX shot up with the S&P dropping — and never got back near the levels we saw early in the day.


At one point the VIX was heading toward 16 even — then it almost got to 19.


Clearly, the levels we are trading at are starting to create a wall of worry.


We also saw the VVIX (the VIX of the VIX) get a little pop:


Although I would point out that it didn’t take off, which, glass half-full (for the SPX), would mean we go higher.


But I am watching VIX closely here.


We are not near a yellow Option Pit VIX light yet — but we are not BURNING red anymore either.


As a quick reminder, the light is my proprietary indicator that guides my volatility trading …


        • Red: The market is falling or staying stable. You can create a trading system and run your normal risk approaches. For instance, the light will be red during a contango market (that’s when the forward price is higher than the spot price — not a lot of worry in the market!).
        • Yellow: The market could go either way. Not the best time for normal investing. Tap the brakes.
        • Green: It’s time to be hedged up and ready for ugliness and opportunity. As an example, the light will be green during backwardation. (That happens when the forward price is lower than the spot price. Fear is in the air!)


Despite not being bright red, the big paper was still bearish.


The biggest trade of the day was a VIX June 20-16 put 1 by 2,  with the customer buying 10,000 20 puts and selling 20,000 16 puts paying .80.


This is bearish VIX down to 12.80.


The point is, I saw a lot of mixed signals, some of which are troubling. I am not ready to say vol is going higher, but we could be in this range for a bit.


The Option Pit VIX Light is Red, and Volatility Is Likely to Drop.


Your Only Option


Mark Sebastian

Trade Flow Points to This …

The Option Pit VIX Light Is Red, and Volatility Will Drop.

Hey Traders,

Average daily volume in the VIX has ticked up to about 510,000 contracts per day after running below 500k for a few weeks there.

This increase in volume is firstly bullish stock on the CBOE.

However … Wednesday was NOT a busy day.

VIX options traded 359,755 contracts — well below the average daily volume.

And It could have been much worse …

But there was one month a group of strikes was active — VIX June puts.

Check it out …

Between the June 17, 16 and 15 puts, 100,859 options changed hands.

Almost all of these options were purchased by institutional customers, mostly in large block size.  

The biggest trade of the day was a buy of the June 16 puts for .29, the second was a buy of the 15 puts for .15.

The largest trading in puts outside of June was the May 17 puts, which also saw an influx of buyers. One trader alone bought 9,300 of the 17 puts for .44.

So what does all of this mean on a Federal Open Market Committee (FOMC) day?

The answer: Traders continue to position for the VIX to drop. 

In the May expiry, the only contract that has over 100,000 open is the 60 strike (good luck!).

Puts, on the other hand, have open interest exceeding 100,000 contracts on the 23, 21, 20, 18, 17 and 16 strike.

In June, open interest is over 100,000 on the June 50s (again, good luck) and the 16s and 15s.  

This type of trading action points toward an impending collapse in VIX to sub-15.

What’s It Mean for Me? (And You!)

Guess what? This would play directly in my hands!

Traders in the beefed-up Volatility Edge program know I bought the May 15 puts for .10 and .05 and that I am long the June 20-17-14 put butterfly.  

This also plays into the hands of the VXX trade I have been discussing over the last couple of days.

I fully expect them both to win. (And there’s still a chance for you to join me.)

Because Option Pit VIX Light Continues to Blare Red, and Volatility Is Very Likely to Drop.

Your Only Option,

Mark Sebastian

Like the (head) wind

The Option Pit VIX Light Is Red, and Volatility Will Drop.

Hey Traders,

The VXX is an ETP that holds VIX futures.

The basket of futures VXX holds have a constant duration of 30 days to expiration … So it’s always 30 days until expiration for those futures — today, tomorrow and in a year.

But how does VXX keep that constant?

The answer is simple — every day it rolls out of near-dated futures contracts and buys longer-dated futures contracts.

So, on the day VIX futures expire, the VXX is carrying 100% the next month out.

For example, when April VIX futures expired on Wednesday, April 21, VXX was carrying a portfolio that was 100% May VIX futures.

Why? Because those futures had exactly 30 days to expire.

The next day, when the May futures had 29 days to expire, the VXX sold a small portion of its holdings in May and bought June futures.

Why is this important?

Because this rolling is what creates the headwind.

Let me show you graphically.

This is a picture of two VIX futures curves. The blue is Tuesday’s settle; the green is the futures curve from April 19.

The VIX itself closed $17.56 on Tuesday. At expiration, the May futures will eventually converge with VIX.

Now, take a look at the May dot plots. What happened to May futures from April 19 to Tuesday? They dropped.

Not all at once mind you, but a little bit each day.

Over that period of time, VXX began selling those futures to buy June.

As that happened, every day, VXX was selling its existing May futures position, the one that started at $20.65  and by Tuesday had fallen to $19.85.

The .80 that decayed out of the May VIX future, even as VIX was relatively stable, is where the headwind for VXX is created.

By calculating how much time there is to expire, and where the current VIX is trading,  my team can calculate exactly how much VXX should lose each day, assuming that the VIX does not move.

If the VIX goes up, the loss to VXX will be less — or VXX could even go up.

If the VIX goes down, VXX can lose even more.

Basically, on a daily basis, VIX can determine the direction of VXX, but over time, VXX is 100% driven by VIX futures term structure.

So, when I said VXX has a $5 headwind, we figured this out by calculating where VIX futures were trading and how much they needed to drop between yesterday’s date and expiration.  

In addition, we take into account the rolling that  occurs and adjust the daily decay as the basket changes from heavy May futures to more and more June futures.

My Trade

Now to my trade …

I hope you can see why I like my put spread so much.  

Using the calculations I have on roll,  I can basically throw out my normal VIX biases, and simply go long a near the money put that has high odds of ending up deeply in the money,  

I then sell a put that has much longer odds of VXX decay hitting it.  This mitigates some of my risk of a VIX rally (I can buy back the VXX 35 puts if VIX does pop for cheap) and reduces my cost.

The Option Pit VIX Light Is Red, and Volatility Will Drop.

Your Only Option,

Mark Sebastian

Spread It Out on the VIX Drop

The Option Pit VIX Light Is Red, and Volatility Will Drop.

Hey Traders,

The VIX did its normal thing on Monday — it rose marginally.

But we could really see what was happening in the VIX futures, which shifted week-over-week:

The front two futures dropped week-over-week, although May and June did NOT drop as much as the previous week’s future curve would have predicted.

If it had dropped as expected, those blue dots would literally be ON the purple line from last week.

Interestingly we saw a rise in VIX futures in the back months, with July on rising a touch.

As it stands now, this curve is going to put downside pressure on iPath S&P 500 VIX Short-Term Futures ETN (VXX), although, remember, if the VIX futures don’t move, neither will VXX.

VXX, as it stands, should, all other things equal, lose a little more than .25 cents per day.

One of the great things about the recent VXX reverse split is that …

While the percentage drop it loses per day is the same as pre-split, the raw dollar drop is much bigger.

With May options having 24 days to expire as of Tuesday, it means the VXX is set to lose more than $5 between now and May expiration …

Yet, the May 39 puts only cost about 2.75.

My Trade

Knowing VXX is likely to drop by about $5 (I usually like to discount a few cents for the invariable up and down movements), I like to reduce the cost of the puts I buy, by selling a further out-of-the-money put — thereby creating a put spread.

Yesterday, the trade I sent out to the Vol Edge clients was to buy the 39 puts and sell the 35 puts, paying about 1.90.

This means I am betting 1.90 to make $2.10 … on an instrument that costs $4 — but has a $5 dollar headwind on it.

You can see the payoff here:

I ended up paying 1.95 (I have to wait to trade until AFTER we send out my trade idea to my subscribers) …

And I expect this trade to make a minimum 50% return over the next two weeks.

If VIX rises, I will be hedging using VIX calls, rather than dumping the position.

The Option Pit VIX Light Is Red, and Volatility Will Drop.

Your Only Option,

Mark Sebastian

Today Was the Day

Hey, Traders.

The VXX reverse split on Friday.

Earlier today the  ETP was trading 39.75 with ¼ the shares outstanding.

If you had 100 shares for $10 on Thursday, you had 25 shares for $40 on Friday.

No change in dollars — but a big change in VXX price.

This is big, because the decay we track in VXX — the one created by the VIX contango that looks like this …

… that decay is calculated as a percentage of the underlying price of VXX.

That means if VXX was losing 1% a day at $10, it is still losing 1% a day at $40.

The difference is that 1% ballooned from .10 to .40!

So if this all happened on Friday, why was today the “BIG DAY?”

Because VXX listed the new options on the reverse split price.

This means I can now trade options on the adjusted price of VXX!!

This also means there is a huge opportunity to take advantage of that big contango and falling VIX to make money fading this product.

I released a juicy VXX trade today for my Volatility Edge clients.

I’ll tell you exactly what I did tomorrow …

The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop.

Your Only Option,

Mark Sebastian

Flow Tells the Story

The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop

Hey Traders,

The VIX closed at 18.71 on Thursday, up 1.21 points from the previous finish — and even briefly traded above 19.

You would think that, with the top capital gains rate potentially doubling, traders would be worried.

And given the VIX rally, I was expecting to see a lot of call trading …

But take a look at the option volumes in May (the green numbers):

Between the 15 and 30 strike — the strikes that could actually come into play — there was not a single call strike that had five figures

At the same time, three strikes had more than 10,000 in the puts, including a buy of 20,000 May 17 puts.

What does this mean?

It means that traders were fading the move. (Fading, you’ll recall, is buying or selling the opposite direction of a price movement.)

Take a look at the price action of VIX futures below.

The purple line is Tuesday’s close, the blue is Thursday’s …

Remember, the S&P 500 is basically unchanged over that time period (but saw two 38-point move days).

Near-dated futures actually closed lower today than they did on Tuesday. The curve is basically unchanged, meanwhile, but the futures are lower having slid down the curve.

So Thursday feels like a one-off event.

Markets will gather themselves and press on, if not today, then probably Tuesday of next week.

VIX paper sees the index more likely to be below 17 than above 20 anytime soon — the option volume clearly says so.

Yesterday in Volatility Edge we bought the May 15 puts, and I was bidding .05 for more.

And I would LOVE to buy those for a .05, but more proof they (big money) wasn’t buying the selloff — I couldn’t get filled!

The Option Pit VIX Light Is Red, and Volatility Is Likely to Drop

Your Only Option

Mark Sebastian

PS – Don’t forget that the VXX reverse splits 4-for-1 today, so no need to be alarmed when it’s trading 40.