Tuesday, August 14, 2012
The options market is pricing in a HUGE increase in volatility.
And since increases in volatility typically happen as stocks move lower, let's throw one more indicator into the bearish camp...
The Volatility Index (aka the "VIX") – which serves as the market's "fear gauge" – continues to show a sense of complacency in the stock market. It has been one month since we last looked at the VIX and remarked at how complacent investors appeared to be. And if they were complacent one month ago, they're borderline comatose today.
Here's an updated look at the VIX...
The VIX has drifted all the way back down to where it was just before the market peaked in late March. That's a pretty good reason to be cautious here. But we can get an even better reason by looking at the action in the VIX options.
VIX call options are 10 times more expensive than VIX put options. In other words, option traders are willing to pay 10 times more to bet on an increase in volatility than to bet on a further decrease.
For example... with the VIX trading just above 14, the VIX September 15 call options closed on Friday at $3.60. The VIX September 15 call options – which are intrinsically worth $0.75 – are trading for only $0.35.
VIX options are European-style contracts – meaning they can only be exercised on option-expiration day. This eliminates any possible "arbitrage" effect (the act of buying an option, exercising it immediately, and selling the underlying security for a profit).
So VIX options will often trade at a discount to intrinsic value. But you won't usually see such an enormous difference in the price of the call options compared to the price of the puts – except before the VIX makes a big move higher. (You can read more about this strategy here.)
VIX option traders think there's a 10-times-greater chance of the VIX moving higher rather than lower into September option expiration day. Since a rising VIX usually happens as stocks decline, you could argue there's a 10-times-greater chance of a market selloff than a continued rally.
Like I said before... it's another reason to be a little extra cautious right now.
Best regards and good trading,
The VIX isn't the only indicator flashing a warning signal in the market today. Last week, Jeff showed Growth Stock Wire readers a bearish chart that indicates the stock market may be nearing a hard decline. Read more here.
Food costs are about to go up... wheat and corn prices jump 45% and 35% over the past three months.
Complete wipeout for electric-car battery-makers... A123 Systems plunges 94% since early 2011, and Ener1 declares bankruptcy.
World Dominators remain in a long-term uptrend... ExxonMobil, Microsoft, and Wal-Mart are all up 25%-plus over the past year, including dividends.
Cable companies are doing fine... Time Warner Cable, DirecTV, and Liberty Global touch fresh multi-year highs.