Never Fear, Volatility Is Here

Hey Traders,

Phew! Talk about a topsy-turvy week on the markets!

After a tumultuous week fueled by headlines about tech stock woes, inflation fears, gas shortages, and just some general doom-and-gloom, trust me, I get why people are scared to have their money in the market. 

Even bonds had a rough go at it this week. Just look at the iShares 20+ Year Treasury Bond ETF (Ticker: TLT) over the last few weeks …

You know things are crazy when bonds and stocks are both down!

All of this begs the question …

“What should I do?”

Where are investors supposed to turn when it feels like the whole market’s in chaos?

And how was I already onto it last week?

It may seem counter-intuitive, but when it seems like the markets are in chaos, I turn to volatility for shelter.

Yep, good old volatility – specifically, the Cboe Volatility Index (Ticker: VIX) as well as the iPath Series B S&P 500 VIX Short-Term Futures ETN (Ticker: VXX).

Now, it’s true, I have something of a soft spot for the VIX. You could say the VIX and I go way back … After all, I was literally in the room at the Cboe when the indicator known as the market’s “fear gauge” was created.

So, yes, I like to keep my eye on the VIX and VIX futures.

But it’s not just me. Traders of all types monitor the VIX as a way to keep a finger on the pulse of broader market sentiment, and many of them look to the VIX as an alternative investment when everything else is getting shellacked.

Now, a quick refresher for those of you who haven’t “VIX’d” in a while. Like I mentioned above, the VIX is often referred to as the market’s “fear gauge.” 

Essentially, it’s a measure of traders’ short-term volatility expectations based on the price of S&P 500 (Ticker: SPX) options. 

The thought process behind this is that higher options prices represent a greater demand for options (basic supply and demand). Because the greater demand for options signals higher expectations of sudden price changes in the market, there’s higher levels of implied volatility priced in.

So when SPX option prices rise, the VIX goes higher. A higher VIX means there’s a higher expectation of market movement. A lower VIX indicates that fewer traders are anticipating any big price movement in the near future.

Note the inverse correlation between the SPX and VIX over the last two weeks.

Take a look at the VIX last week. As the market was taking it on the chin, the VIX was rocketing higher!

And with my Option Pit VIX Light … I got a head start on preparing.

Light It Up

What is the Option Pit VIX Light? I’m glad you asked!

I created this proprietary indicator specifically for times like these … To give me a heads up when the VIX is about to make a move.

Like a stoplight, the VIX Light has three colors:

      • Green light – Volatility is likely to move higher.
      • Yellow light – The VIX is gearing up to make a move.
      • Red light – Volatility is falling, or may simply remain stable.

Generally, a green light means now is a good time to buy volatility, while a red light is a good time to sell volatility. A yellow light is a somewhat neutral indicator, since it indicates only that there may be a big move coming up … But it doesn’t indicate the direction of that move.

Without getting too granular, I look at four sub-indicators when deciding the color of the VIX Light:

      • VIX Curve
      • VIX Correlation
      • VIX Volatility
      • VVIX (Volatility of VIX Options)

When each sub-indicator changes, I adjust the VIX Light accordingly. 

Lately, the VIX Light has been red pretty consistently. In fact, I think the last time we saw something besides red was mid-March.

So when it switched to yellow last Thursday, my spidey-senses knew something was up.

What triggered the change was my VIX Correlation sub-indicator flashing green. With the S&P 500 and VIX both headed higher, I knew this could spell out some big market moves in the near future. 

And it also told me to expect some movement out of the VIX.

Now, of course, a “big move” could technically happen in either direction. Which means it’s up to me to search out clues about which way things could be headed.

But nothing like a little advance warning to let me know it might be time to batten down the hatches!

I was able to adjust my trading strategy, and keep an eye out for trading opportunities that would play out in my favor in the event of a VIX spike … Which happened less than a week later!

The moral of the story?

Watch the VIX. 

When everything else seems to be selling off … You’ll often see the VIX climbing higher. This can present excellent buying opportunities for anyone looking to get out of equities or bonds during a market downturn.

And if you’d like to receive daily Option Pit VIX Light updates, regular volatility-based trades, plus a whole lot more, you can join my Volatility Edge program right here.

Your Only Option,

Mark Sebastian

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