War is bullish.
Yes… it’s an unfortunate truth that death and destruction is often the catalyst for higher stock prices. But, it is the truth nonetheless.
While the stock market often sells off on the initial headline about military action, it usually recovers that loss quickly and then shoots higher. So, the military action that started in Iran this past weekend should favor the bulls in the days ahead.
Just to be on the safe side, though, let’s gaze into our crystal ball to see if it leans bullish, too.
Regular readers know about the predictive power of VIX option prices. We’ve used extreme deviations in option prices before as a sort of “crystal ball” for the immediate direction of the stock market.
Right now, the prices of VIX option contracts are suggesting a slightly lower VIX over the next few days, and the next few weeks. And, a lower VIX usually goes along with a higher stock market.
For example, yesterday, as the VIX was trading above $22, the VIX March 3 $22 calls were trading for $0.80. Meanwhile, the VIX March 3 $22 puts were trading for $1.10.
VIX put options are more expensive than the equivalent call options. This suggests the VIX will be lower tomorrow than where it was yesterday.
The price difference is not as extreme as we have seen it before. Indeed, we’ve often peered into the crystal ball and seen VIX calls trade for five or even 10 times the value of the equivalent puts, and vice versa. The current difference is negligible by comparison.
So, the setup favors the bulls… but not by much.
If we go out a bit further in time, the picture isn’t any different. The VIX March 18 $22 calls traded yesterday for $1.90 while the equivalent put option was $2.50.
In other words, traders were willing to pay a slightly higher premium to bet on a lower VIX by mid-March than a higher one.
So, the crystal ball is leaning in the bullish direction.
It’s not as definitive a sign as we’ve seen before. But, when combined with the bullish tendency of stocks to rally on the outbreak of military action, traders making short-term bets on market direction for the next week or two should favor the upside.
Best regards and good trading,
Jeff Clark
Editor, Market Minute