The Option Pit VIX Light Is Yellow: Volatility Is Going To Move.

Hey Traders,

If you had left on Friday and didn’t look at the S&P 500 (Ticker: SPX) until Tuesday afternoon, you might think nothing had happened …

Oh, but things happened!

The market is seriously volatile right now.

In addition … we have VIX options and futures expiration today!

With July derivatives rolling off, some things are going to change dramatically for VIX, iPath Series B S&P 500 VIX Short-Term Futures ETN (Ticker: VXX), and ProShares Ultra VIX Short Term Futures ETF (Ticker: UVXY).

Here is what is happening, and what to do …

The S&P 500 is essentially where it closed on Friday … the VIX? Not so much …

Take a look. The top chart is the SPX, the bottom is the VIX:

The S&P 500 is essentially flat over the last five days …

The VIX is up about three points.

The reason? Well, volatility has really ticked higher.

Before today, the last two days brought moves of 1.5%, and about a 22 VIX, if you’re basing it on realized volatility.

Part of this has to do with the VIX expiration today (Wednesday) …

There is a lot of open interest in July VIX futures and options.

With all the flying around the VIX has been doing, and July VIX futures super-sensitive to VIX movement, the gamma (which measures the change in delta — see our glossary here) created by July options has had a profound effect on the VIX blow-up.

August is not nearly as active so far as July was.

July options have ten strikes with over 100,000 open interest, and several with more than 200,000 open contracts …

August only has four strikes with over 100,000 contracts open, and ZERO strikes with over 200,000 contracts of open interest …

This is significantly less market involvement.

While that will change with time, for now, the lack of open interest is likely to reduce the volatility of VIX, and especially VIX futures.

So what does this mean?

It means VIX is going to move less swiftly with the S&P 500 until some activity picks up in August VIX options.

This creates an interesting chance to look at selling call spreads in UVXY or VXX, or even VIX itself for that matter.

I also think that VIX hedges may need some adjusting, because if you think the VIX is going to move as hard as it did on Monday, you are probably wrong.

Your Only Option,

Mark Sebastian