The Option Pit VIX Traffic Light is Red: Volatility Is Likely to Drop.

Hey Traders,

Yes, I moved the light to red.

It’s not because I don’t think there cannot be a crazy move … there totally could be this week.

But with VIX falling and the S&P 500 (Ticker: SPX) falling on Tuesday, it’s a pretty strong sign that volatility is going to come down.

So what is next for the VIX?

The VIX settled down on the day Tuesday despite the Nasdaq-100 (Ticker:  NDX) being down 0.48%, and the SPX being marginally down by 4.84 points..

The VIX is now at its lowest level since November 17th.

So what is next?

I think there could be more downside …

Yes, the possibility for a one day pop is out there, but take a look at SPX and VIX from today:

Even as the SPX held down on the day, and made some pushes to actually sell off, VIX never really got a lift …

While the easy upside on the SPX might be done for the week (Monday made sure of that),  there is the distinct possibility that VIX continues to drift lower.

Even when the VIX was up in the AM on Tuesday, VIX futures were down and closed on the lows of the day.

So how do you play this?

With the current shape of the VIX, there is plenty of decay in ProShares Ultra VIX Short Term Futures ETF (Ticker: UVXY) or iPath S&P 500 VIX Short-Term Futures ETN (Ticker: VXX):

The spread between cash and the future is about three points.

Before I believe VIX itself is oversold, I would like to see this spread get to four points.

I could see that happening with the VIX around 15.50-16.00, and the VIX futures near 19.50-20.

That process would take UVXY down another $1.50-$2.00, and could make long puts in UVXY or VIX itself quite profitable.

So how can you play this?

Simple …

There is value in the 18-strike and 17-strike puts…

I would hedge them off on a ratio of 1-to-10 by buying the VIX 22-30 call spread for $1.00.

I can make money on that trade.

Your Only Option,

Mark Sebastian