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