Time To Go Bearish On Vol?

The Option Pit VIX Light Is Red, And Volatility Is Likely To Drop.

Hey Traders,

Well, I switched the Option Pit VIX Traffic Light to red.

I will say, it’s a close call, and is right on the cusp …

Despite the system using four indicators, things just were not in agreement.

At that point, I have to use my 20 years of trading experience to make a judgement call.

Here is why I went red, and what I am doing …

Seeing Red

The Option Pit VIX Light is red.

Why, you may wonder, when things haven’t changed?

Well, for starters, yes, things have changed. 

I’m going to show you two different trends on one chart:

The top chart is the S&P 500 (Ticker: SPX) since June 28th. Notice it has been moving higher, and is currently up about 150 points.

The second chart is VIX.

I want you to first look at the long line from June. Notice the VIX is also up over that same period of time.

This is what perked my ears a couple of weeks ago.

Now look at the second line …

That is the VIX since the start of August.

Notice VIX is trending lower, and does so even on days the SPX is down …

This week-long period of negative correlation and sinking volatility is a bearish sign for the VIX.

Next, we have this contango (futures trading progressively higher than spot) in VIX futures, which has been the hold-out indicator the whole time (proof that VIX guys know what they’re doing!).

The VIX futures curve continues to be in a nice contango, and has even steepened in some of the back months …

This is also a bearish sign for volatility.

It is time to short volatility in full, although I would push to have some sort of hedge on VIX options.

I am long and would be a buyer of the August 18-strike and 17-strike puts in VIX.

They have a huge edge, even if the VIX just stays here.

Take the 17-strike puts:

There are over 200,000 put owners out there. The puts are essentially at parity with the cash VIX.  

They are also cheap.

If the VIX drops, these will really perk up this week and could more than double in a day.

If the VIX pops … well, I’ll be able to get out for $0.15.

Your Only Option,

Mark Sebastian

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