Tuesday, October 20, 2015
The Volatility Index ("VIX") has collapsed.
After trading as high as 40 in early September, the stock market's fear gauge closed at just 15 last week. It's trading back down at the same level it was when the S&P 500 was making new all-time highs in May.
That action isn't too surprising. The VIX tends to move in the opposite direction of stock prices. As stocks rally, fear dissipates, and the VIX drops. When the stock market falls, investors get more fearful, and the VIX runs higher.
The stock market has put on one heck of a rally over the past few weeks. As a result, the VIX has been crushed.
Now though, it looks like fear is ready to make a comeback.
Let me explain...
Regular readers are familiar with VIX options... I've written about their predictive power before. You see, VIX options are European-style contracts – meaning they can only be exercised on option-expiration day. So they provide terrific clues about where most traders expect the VIX to be in the future.
For example, back in June, when the S&P 500 was trading near an all-time high, the VIX call options were significantly more expensive than the VIX put options. In other words, options traders were betting that the VIX would move higher. And since a higher VIX is usually associated with a lower stock market, this was a good reason to be cautious on stock prices.
The S&P 500 lost 75 points over the next two weeks. It lost 250 points over the next two months.
Last Friday, the VIX closed at 15.05. The VIX October $15 put options – which expire on Wednesday – closed at just $0.10. Meanwhile, the VIX October $15 calls closed at $1.50.
So options traders are willing to pay 15 times more to bet on the VIX moving higher by Wednesday.
Going out to November... the VIX November $15 calls – which expire on November 18 – closed Friday at $3.00. The VIX November $15 puts closed at $0.50.
Traders are willing to pay six times more to bet that the VIX will move higher over the next month.
In short, it looks like we're due for an increase in fear. And that usually means a lower stock market.
Best regards and good trading,
Find more of Jeff's recent research here:
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