The Stock Market’s ‘Crystal Ball’ Just Turned Bullish

Stop worrying about a stock market crash. It isn’t going to happen. At least, not yet.

The stock market’s “crystal ball” has turned bullish. There’s a good chance the S&P 500 will be higher one month from now than where it is today.

[ad#Google Adsense 336×280-IA]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.

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.

But it’s the VIX option prices that can tell traders where the VIX is headed, and by extension, where the stock market is headed. And right now, the market’s crystal ball is sending traders a bullish signal…

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 then selling the underlying security for a profit). So VIX options will often trade at a discount to intrinsic value.

For example, on Tuesday, the VIX closed around 26.50. At that level, the VIX February $20 calls are intrinsically worth about $6.50. But they were being offered for only $5.40. That’s a $1.10 discount to intrinsic value.

If it existed as a regular American-style stock option, you could buy the call, exercise it, and liquidate the position all day long, picking up $110 for every contract you traded. The European-style feature prevents that from happening – because you can only exercise this contract on February’s option-expiration day.

VIX options provide terrific clues about where most traders expect the Volatility Index to be when the options expire.

The current VIX option prices tell us traders expect the index to start moving lower soon.

With the VIX at $26, the VIX March $26 calls – which have $0.50 worth of intrinsic value – closed Tuesday at $2.70. The VIX March $26 puts – which are $0.54 out of the money – closed at $4.30.

In other words, the VIX puts were at least 60% more expensive than the VIX call options. Traders are willing to pay 60% more to bet that the VIX will be lower by option-expiration day in March. And, a lower VIX usually coincides with a rising stock market.

This sentiment is just as evident if you compare the VIX April $26 calls to the VIX April $26 puts. These options expire on April 20. The calls closed Tuesday at $3.20, while the puts were at $5.30. (I use my trading-quote system to track these prices, but you can find them here.)

The price difference isn’t enough to suggest that we’re about to see a rip-roaring stock market rally. But it is enough of a difference to suggest the S&P 500 could put on a decent bounce over the next month or two – perhaps back up to the 20-month exponential moving average near 1,970.

Then we can start worrying about a crash.

Best regards and good trading,

Jeff Clark

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Source: Growth Stock Wire