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.[ad#Google Adsense 336×280-IA]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,
Source: The Growth Stock Wire