I Call Top (And Bottom)

The Option Pit VIX Light Is Red, and I like short volatility plays.

 

Hey Traders,

 

There are two major volatility indexes for the NASDAQ 100 …

    • VXN: Essentially the VIX calculation, but run over NDX options. This index uses all options that have a value (a bid) and calculates the overall implied volatility of the NDX with a constant duration of 30 days.
    • VOLQ: The newer of the two volatility indexes is based on QQQ options (the smaller version of NDX). Does not look at all options with 30 days to expire. Its calculation comes from the options that are at-the-money (where QQQ is trading) and the strikes directly around the ATM option strike.

 

While the two indexes both provide valuable information on whether traders are buying or selling options …

 

It is in running the two against each other that I have found REALLY valuable market insight.

 

Tops & Bottoms
If I take the VXN and subtract VOLQ from it on a chart, I get an output that looks like this:

 


What are we seeing?

 

At the lows, the spread almost got to flat. This means that at-the-money options were so high, there was virtually no difference in volatility across strikes …

 

Skew is the volatility relationship between out-of-the-money options and ATM options. 

 

When OTM options are expensive in terms of implied volatility, skew is “steep.” By the same token, when they are inexpensive, skew is flat.

 

In this case skew was flat — OTM puts and OTM calls had almost the same implied volatility as ATM options.

 

Notice this took place at the March lows.

 

Another low took place in mid-September. What was happening then?

 

The NDX was at the tail end of a 1500 point sell off.

 

Now take a look at the highs.

 

Generally speaking, the spread tops out at around 5.5. 

 

The high from the Feb 12 almost EXACTLY corresponds with where the current 8% selloff (at the lows yesterday) started.

 

Take a look at the NDX over the VXN-VOLQ since Aug. 15 of last year …

 

 

Interesting …


All of the peaks and valleys of VXN-VOLQ correspond to turning points for NDX.

 

Using these two indexes to track NDX skew really is eye opening …

 

How About Now?


So what are they saying now?

 

As you can see  above, the spread has flattened up considerably.

 

This tells me that we could be ending the NDX/QQQ unwind from last week.

 

While the spread of 3.93 COULD tighten further, if it gets to under 3, and certainly if it goes to 2.5, that signifies an opportunity to go long the QQQ …

 

Unless we are in the midst of a giant sell off — in which case I would wait to buy for SIZE until we get a number under 1.

 

At sub-3 on this spread I would begin buying and I would go BIG long QQQ if it gets to below 1.

 

The Option Pit VIX Light Is Red, and I like short volatility plays.

 

Your Only Option,


Mark Sebastian

 

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