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One More Reason to Expect a Selloff

By Jeff Clark
Thursday, March 18, 2010

It's happening again...
 
Stocks are powering up to new 52-week highs, while the Volatility Index (VIX) – aka the "fear index" – drifts down to a new yearly low.
 
The inverse correlation between the VIX and the stock market shouldn't surprise anyone. We've written about it often enough in Growth Stock Wire. And it's well known on Wall Street sustained market rallies usually generate complacency among investors, which, in turn, creates a declining VIX.
 
What is less well known, however, is that after drifting down to a new low, the VIX has a nasty habit of suddenly reversing – especially if the new low is made during VIX option-expiration week. And the March VIX options expired yesterday.
 
Take a look at this six-month chart of the VIX...
 
 
The blue circles highlight the last five VIX option-expiration dates. In each case (except for February), the volatility index spiked sharply higher right after option expiration. Spikes in volatility coincide with sharp drops in the market. So in each case (except for February), the market dropped as well.
 
All of these moves were forecast by VIX option prices. Let me explain...
 
Following October expiration, the November VIX call options were much more expensive than the November puts. When November options expired, the December VIX call options were more expensive than the puts. Ditto for when the December and January options expired as well.
 
The exception was after the February VIX options expired. March puts and calls were evenly priced. This was the only time in the past six months the VIX didn't spike higher... and the only time stocks didn't drop lower immediately following VIX options expiration.
 
So in four of the past five months, VIX call options were much more expensive than the puts following option-expiration day. The market sold off in every case.
 
Last month, when the puts and calls were evenly priced, stocks didn't sell off.
 
This brings us to today...
 
VIX options for March expired yesterday. The VIX closed at just under 17. The VIX April 17 put options are trading for $0.30 while the April 17 calls are $3.30 – eleven times more expensive.
 
Clearly, the options market is pricing in the potential for a sharp increase in volatility. And since higher volatility usually coincides with a lower stock market, VIX options are forecasting a sharp reversal here.
 
Best regards and good trading,
 
Jeff Clark




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Market Watch
Symbol Price
Change
52-Wk
S&P 500 1221.53 +1.3% +10.1%
Oil 38.31 +1.4% -0.6%
Gold 138.07 +2.1% +16.3%
Silver 28.60 +2.4% +53.6%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 18.01 -7.1% -19.8%
Gold Stocks 581.56 +3.0% +17.0%
10-Year Yield 3.02 +0.7% -10.7%

World ETFs
Symbol Price
Change
52-Wk
USA 122.89 +0.3% +11.3%
Canada 30.50 +0.2% +16.2%
Russia 21.94 +1.4% +18.1%
India 37.85 +0.3% +22.3%
Israel 16.69 +1.3% +10.8%
Japan 10.64 +0.6% +6.5%
Singapore 13.73 -1.1% +18.8%
Taiwan 14.78 +0.4% +19.2%
S. Korea 57.31 +1.3% +23.4%
S. Africa 71.87 +1.4% +28.2%
China 44.42 -1.4% -0.6%
Lat.America 53.17 +0.7% +8.4%

Sector ETFs
Symbol Price
Change
52-Wk
Oil Service 137.59 +1.0% +18.9%
Big Pharma 64.14 +0.0% -3.2%
Internet 72.07 -0.1% +23.4%
Semis 16.22 +1.2% +29.4%
Utilities 31.28 +0.2% +1.5%
Defense 18.52 +0.1% +10.6%
Nanotech 10.03 +0.4% +1.6%
Alt. Energy 10.08 +1.3% -3.3%
Water 18.49 +1.0% +14.5%
Insurance 16.14 +0.4% +21.1%
Biotech 20.54 -0.2% +28.1%
Retail 19.70 +0.3% +30.2%
Software 24.79 +0.8% +25.9%
Big Tech 53.87 +0.3% +22.7%
Construction 13.10 +0.9% +15.7%
Media 13.64 +0.5% +26.0%
Consumer Svcs 67.39 +0.2% +24.5%
Financials 55.04 +0.3% +7.4%
Health Care 64.30 +0.1% +2.0%
Industrials 63.54 +0.5% +21.0%
Basic Mat 74.35 +1.1% +25.3%
Real Estate 55.32 +0.1% +25.0%
Transportation 91.77 +0.7% +26.9%
Telecom 22.59 +0.5% +17.8%