The Option Pit VIX light Is Yellow, and volatility will move, though direction isn’t certain.

Hey Traders,

On Monday, I discussed the relationship between VIX and VXN — the VIX of Nasdaq 100 (NDX) options — to illustrate how high Nasdaq 100 volatility is right now.

That spread, which was wide already, stretched MORE as the day progressed, closing at a six-month high of 8.4. (But remember, we have seen it go higher than 10 in the past.)

The QQQ — an ETF that tracks the Nasdaq 100 Index — got absolutely wrecked on Monday, closing down 2.92%, while the Dow Jones Industrial Average (DJIA) was up almost 1%.

But …

I think we are nearing an end to this.

Here’s why …

Consider the relationship between VXN and VOLQ.

Remember VXN is modeled after VIX and includes all options with a bid in its calculation. VOLQ, on the other hand, only uses at-the-money option implied volatility.

When the spread tightens, it’s a sign that skew (the volatility relationship between at-the-money options and out-of-the-money options) is flattening.

A flatter skew occurs when the market is at a bottom, because traders are selling stock and buying calls to hedge instead of buying out-of-the money puts.

Since the craziness of March 2020 subsided, VXN/VOLQ spread has closed below 2 just three times: last July, September and October.

Each occasion was at the back end of major selling.

On Monday, the spread closed below 2 for the fourth time in a year … VXN closed 33.87 and VOLQ closed 32.07.

As you can see, the spread can go to 1 when things get really bad, typically within a day or two of breaking 2.

When that happens, it’s a sign that QQQ is into the WAY oversold phase.

I think the tech selloff is nearing an end in the next day or two, and the sector is likely to bounce.

That will likely pull the S&P 500 up — and I like the index to make a nice bull run the back half of the week.

The Option Pit VIX light Is Yellow, and volatility will move, though direction isn’t certain.

Your Only Option,

Mark Sebastian