It’s time to turn our attention again to the one indicator I follow more than any other when I want to know where the stock market is headed next…
As regular readers know, I monitor the price action in the Volatility Index (“VIX”) call and put options as a way to predict the stock market’s next move. It’s like staring into a “crystal ball” for the market.
The Volatility Index is a measurement of fear in the marketplace.[ad#Google Adsense 336×280-IA]When the VIX is high and rising, investors are scared and traders are bearish.
A low and declining VIX indicates strong bullish sentiment and complacency among traders.
Right now, the market’s crystal ball is sending traders an extremely bearish signal.
Let me explain…
I’ve often written about the predictive nature of Volatility Index option prices.
For example, last July, VIX call options with only a couple of weeks remaining before expiration were three times as expensive as the put options. And VIX call options going out three months were seven times more expensive than the puts.
This price disparity signaled that option traders were betting on a higher VIX over both the short and intermediate terms. And since a higher VIX is usually associated with a lower stock market, this was a good reason to be cautious – or even bearish – on stock prices.
The S&P 500 fell 4% over the next two weeks. It fell 7% by October.
Last October, we had the opposite situation. VIX put options for December were twice the price of the call options. Traders were betting on the VIX falling by Christmas. And since a falling VIX usually goes along with a rallying stock market, we were looking for higher stock prices in time for the holidays.
The S&P 500 gained 12% over the next six weeks.
Well… the stock market’s crystal ball is sending traders another signal right now…
On Tuesday, the Volatility Index closed at 12.11. The VIX July $12 calls closed at $2.10, while the July $12 puts were only $0.10. In other words, option traders were willing to pay 21 times more to bet on the VIX moving higher over the next month than on it moving lower.
The difference is even more significant going out to October. The VIX October $12 calls are trading for $4.80, while the October $12 puts are just $0.10. So options traders are willing to pay 48 times more to bet on the VIX moving higher than on it moving lower by the October expiration day.
This is the largest price disparity I have ever seen in the VIX options.
VIX option traders clearly expect volatility to move higher over the next few months. And rising volatility usually translates into falling stock prices. With the market trading near all-time highs, and with all the other bearish indicators I wrote about on Tuesday, it’s time to be cautious right now.
Best regards and good trading,
Source: Growth Stock Wire