The Option Pit VIX Traffic Light Is Yellow: Volatility is likely to move wildly.

The VIX light has been on yellow for months.

It briefly has flashed both red and green in that time,  but not really long enough for a change in trend.

Here’s a quick reminder of how I use the light to help guide my trading:

• Red: When I see (or foresee) the VIX heading down and volatility dropping.
• Yellow: The VIX could go either way depending on a wide number of influences. 

• Green: When the VIX is shooting up and vol is spiking.

So what is going on?

The answer is volatility has been in an all-together decline … but has done so by jumping up and down and landing with a slightly lower resting place:

In October we dropped dropped out of green and into yellow on a nice decline in volatility out  of the lows in the SPX

Since then, as you can see, vol has been choppy in nature but has had a slight drift lower in the process.

In that time, when we look at the movement of the VIX itself, actual VIX volatility has remained high. See below that the average true range has remained very high at over 1.6 points a day:

Meanwhile, realized volatility of the index has consistently been in the 80s …

That kind of VIX movement is going to make playing a longer-term trend difficult, especially using shorter-dated options.

And while the curve has been in a pretty consistent contango at the back end, it has been less stable at the front end of the curve where VIX has jumped over and under the front month future:

So where does all this leave us?

I continue to think the long term trend is down and that we are going to be in a consistent red light before Q3.

In the short term, thogh,  I see a potential move to a green light forming.

So how would I play this?

Pretty simple. Buy long-dated out-of-the-money puts – August or September.

Then trade these up pops with short-dated calls or using SPX strangles.

Questions about that? Leave them in the comments below!

Your Only Option,

Mark Sebastian