The Option Pit VIX Light is Yellow: Volatility is going to move wildly
Hey Traders,
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Now, about that Option Pit VIX Llight…
We did not get a ‘turnaround Tuesday’ on Tuesday.
We got a “how far can markets plummet?” Tuesday …
At the lows, the S&P 500 (Ticker: SPX) was off over 75 points …
VIX was up 2.18 points on the day, and touched as high as 23.73 …
But it was at the lows that we got a glimpse into the VIX that, honestly…
I was a bit surprised to see.
Tuesday was an ugly day almost completely across the board …
But I will say, midday looked a whole lot uglier than when the markets closed.
The S&P managed to rally 40 points off the lows …
And for a little bit, both the Nasdaq 100 (Ticker: NDX) and Russell 2000 (Ticker: RUT) turned green.
But … I would like to show you what I saw at the lows …
It’s called ‘partial backwardation’:
The green line is the cash VIX index.
The yellow is the VIX futures curve.
It’s called ‘partial’ backwardation because the cash index got above a couple of futures prices …
This is a sign that the market is stressed, but that the big money has not started to really get scared.
Traders are racing for puts in the S&P 500 (thus the VIX is rallying) …
But it’s not scary enough to push the futures to break out of their standard formation of contango …
We see this set up in 2 scenarios…
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A VIX spike: This is a short-lived spike in the VIX that quickly fades, leading to a market rally.
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The beginning of a VIX swell: When the market is really due for some heat.
What has me concerned is that VIX correlation was already showing stress for several weeks ahead of this VIX move.
Remember, I changed the VIX light to yellow on Thursday because the VIX was correlating with the SPX …
Now we are starting to see forms of backwardation.
While I don’t think we are heading for some sort of doomsday scenario, I’m also not sure that what we are looking at is a short-and-simple VIX spike.
In other words, we could be heading for a few days — or longer — of market stress.
We are now at 50/50 odds that the VIX Light goes green. All it’s really going to take is one more shot higher in the VIX.
At that point I think the VIX futures are going to have to start reacting …
For that to happen, we will need a real bloodbath of a day though.
Essentially, what I’m saying is that I have started to add hedges to my trading in anticipation of a major VIX pop. The VIX May 25-40 call spread costs about $0.75. That’s a nice, inexpensive hedge that is similar to what I’ve been looking to implement.
However, I still would currently lean towards betting that we DON’T get a green light.
But here’s the thing. It doesn’t matter what I think. This is precisely why I built this light: to stop me from making gut-feeling ‘judgement calls’ on volatility.
Volatility begets more volatility. I use the light to remove my own biases. And that might be one of the most useful parts of the VIX Light altogether.
I’ll see you tonight, right? Register here if you want to hear about my top three post-pandemic stock picks (here’s a spoiler… I’m betting on some downside for these ones!) and some of my tips to make yourself a better, more confident trader IMMEDIATELY. See you there!
Your Only Option,
Mark Sebastian