The Option Pit VIX Traffic Light Is Red: Volatility Is Likely To Drop.
Hey Traders,
The VIX started off the week by trading lower …
Not much lower, but lower nonetheless …
This is significant because Monday is the day we are most likely to see the VIX higher.
Why?
Because of the Weekend Effect.
The Weekend Effect essentially refers to the fact that market makers decay out weekend theta during the week.
Because markets are only open five days each week, market makers need to decay out the extra weekend’s worth of time premium during the days the market is open.
So instead of decaying out only five days worth of time premium each week, market makers decay out 6.5 days worth of time premium during the trading week, to take into account the days that the market is closed.
However, the VIX, which measures the implied volatility (IV) of S&P 500 (Ticker: SPX) options, does not take into account this accelerated theta decay.
The VIX actually reads this extra decay as a decrease in implied volatility.
Therefore, the VIX is historically down four days each week.
But on Mondays, when the accelerated decay process has not yet started for S&P 500 options, the VIX is usually higher.
So seeing the VIX even slightly lower (or only slightly higher) on Monday morning is fairly unusual, and significant.
But that is what we saw to start the trading session today.
And even with the VIX now up about 0.5 points … that is essentially flat, or slightly down, taking into account the Weekend Effect …
Now I want to take a look at VIX futures, because unlike VIX, VIX futures trade almost constantly, and therefore they are not subject to the same Weekend Effect.
Right now, VIX futures are trading at quite a premium to VIX index, so we have the VIX curve in a pretty steep contango (which is a big factor of the Option Pit VIX Traffic Light being red) …
And if we look at iPath Series B S&P 500 VIX Short-Term Futures ETN (Ticker: VXX), it is actually a touch lower on the day.
What’s more, the VIX pits are seeing some significant buying volume today …
There seems to be several big traders piling into the December 15-strike puts.
And these puts are CHEAP.
We’re talking $0.10.
With this week’s shortened trading week, we will be seeing an even more prominent Weekend Effect as theta decay is accelerated more than usual.
Assuming the market does not tank (and historically, it does not tank during Thanksgiving week) … I think the VIX could be headed for quite a drop.
However …
I think there is a better way to play a falling VIX than the 15-strike puts.
How?
Personally, I like the VIX December 17-strike puts for $0.50.
Your Only Option,
Mark Sebastian
