The Option Pit VIX Traffic Light Is Yellow: Volatility Is Going To Make Wild Moves.
Hey Traders,
For a second there on Monday, it looked like the wheels would fall off …
But then something happened …
Treasuries began to sell off …
VIX began to sell off …
The Russell 2000 (Ticker: RUT) began to rally.
By the end of the day, the market had shifted from a potential blood bath to a ‘mild sell off.’
But that doesn’t mean this is over.
There is a lot to unpack over the next couple of days between now and the holiday …
And in the week between Christmas and New Years …
Here is what you need to know, and how to trade it.
There are so many balls in the air right now…
The Fed, omicron variant, the holidays …
What should you be paying attention to?
Let’s start with the Fed.
For the coming few months, despite the Fed taper, there is still huge amounts of liquidity coming into the market.
Until the Fed gets its buying down to less than what it was during quantitative easing (QE) at the end of the Great Recession (hint: it’s WAY above that), then I do not think it is a major concern.
Thus I would table this one until February.
Next we have omicron. So far, it appears to be far less lethal, and there are treatments now, unlike in March of 2020.
Is it a short term concern for economies? Yes. Will it cause a recession? Probably not.
But in the near term, the headlines of lockdowns CAN cause the market to sell off, especially over a weekend.
Why over a weekend? Because there is not a lot of other news out there, and traders have time to stew.
The overnight low on Sunday night turned out to be almost exactly the low for the day in the S&P 500 (Ticker: SPX) on Monday. From there, we bounced.
Looking at the holidays …
Are we going to get a Santa Claus rally?
Probably.
Will it come when you want it?
Maybe not.
For the next few days, we have the confluence of tax selling and end-of-year retirement plan tax buying…
In some of the high flyers that have held up this market, there is a lean towards selling.
I mean, if Elon Musk is selling 10% of his holdings, he is not the only one dumping Tesla (Ticker: TSLA) to pay taxes.
At the same time, money does need to be allocated to markets through the end of the year by many with retirement plans.
As tax selling wanes, that is when we could see a rally.
Of course, that is assuming another omicron bomb doesn’t drop, which is a serious possibility.
The other major event this week is VIX expiration…
We have one trading day left in the cycle, Tuesday.
Two weeks ago, I watched the VIX go from 31 to 19 in a week.
Is it possible for VIX to go from 23 to 18 in a day?
It is.
And there is significant open interest at the 20-strike that could cause a gamma squeeze lower if volatility gets faded on Tuesday.
Then as we head into the end of the year, we have holiday short volatility front-running.
This typically happens last week, but with the VIX cycle ending late, and some of the selling over the last 3 days, I think we do not see it until after expiration on Wednesday now…
But it could be something that really forces VIX lower, especially with some of the structured products that need to enter the market place next week/early January.
So what should a trader do?
By Dec. 31, I believe VIX is going to be sub-17. It could see a small pop as it adjusts in the new year, but by January expiration, we could be looking at a 15 VIX again, especially if omicron works itself out quickly.
Take a look at my trade idea from Monday … It was a good one.
Your Only Option,
Mark Sebastian