What This Big Bid On Baby Puts Is Telling Me

Hey Traders,


On Tuesday we saw the market boom higher …


Only to fizzle away, and end the day essentially flat …


So, does this mean we are in for a double top?


Is the S&P 500 (Ticker: SPX) heading for trouble, and will the Option Pit VIX Light flip to yellow?


One index is telling me the answer pretty succinctly …


Let’s take a look at skew.


Skew is the cost of out-of-the-money puts and calls, relative to at-the-money options.


There are a few ways to track it …


One way is to look at VIX-VXO.


The VXO is similar to the VIX, but it tracks options on the OEX (the S&P 100) while the VIX is based on the whole curve of the S&P 500


By subtracting VXO from VIX, I can get a pretty good idea of where skew is at across the curve …



The index differential has been on a steady climb since April.


Another index that gives me a glimpse of skew is the Cboe SKEW index…


This index looks at skew a little differently.


The index is the end-of-day price for ‘crash’ protection puts.


This index was at the high of the year on Friday, and is still super high as of today …



As you can see, small dollar puts in SPX are pretty darn expensive right now …


So what does that mean?


Believe it or not, a big bid for baby puts is bullish.


There is a high correlation between a steep SKEW index and positive market returns …


While that may sound counterintuitive, when you think about it, the correlation makes sense.


If I thought the S&P was going to tank, would I buy little baby puts?


No, I would buy meaty puts that will make money on an impending move lower.


I buy crash puts as a security blanket to protect against doomsday, not just a standard sell off…


If I have the security blanket on, it gives me the comfort to go long …


Which is probably what is being built up.


So, while at first that skew index being so high might ring the alarm bells, in truth, it actually makes me want to go for long calls, not short the market.


An alternative would be puts in ProShares Ultra VIX Short Term Futures ETF (Ticker: UVXY),  like the ones I did today for the Volatility Edge program.


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


Your Only Option,


Mark Sebastian

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