The Volatility Index (VIX) generated a new broad stock market buy signal last Thursday.
But, I’m not buying it – because the “crystal ball” says to sell.
Let me explain…
The VIX closed above its upper Bollinger Band (BB) last Wednesday. Then, the VIX closed back inside the Bollinger Bands on Thursday.
Long-time readers know that’s a VIX buy signal. And VIX buy signals have paid off really well this year.
Just take a look at how the S&P 500 performed following the seven previous buy signals in 2021 (blue arrows)…
In every case, the stock market moved higher right away following the VIX buy signal. And, in six of the seven cases, the market was higher one month later.
So, if we’re playing the odds, we have to side with the bulls on this one.
Thursday’s VIX buy signal should immediately lead to a higher stock market. The market should also be higher one month from now.
The problem, though, is that VIX option prices are telling us a different story. VIX call options are far more expensive than the equivalent VIX put options.
When we’ve seen this condition before, it has almost always led to a higher VIX in the days ahead. And a higher VIX usually goes along with a falling stock market.
This indicator is so accurate that we’ve often referred to the discrepancy in VIX option prices as the stock market’s “crystal ball.” Right now, the crystal ball is bearish.
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The VIX traded down to $16.35 on Friday. At the time, the VIX November 17 $17 calls – which were $0.65 out of the money – were trading for $1.00. The VIX November 17 $17 puts – which were in the money by $0.65 – were trading for $0.50.
In other words, traders were willing to pay twice the price to bet on a higher VIX two days from now, than on a lower VIX.
The discrepancy is even larger if we go out one month… The VIX December 8 $17 calls were trading for $3.35, while the equivalent put options were $0.60.
It’s hard to argue with the VIX buy signal. It has been a highly reliable indicator all year.
But it’s even harder to argue with the crystal ball, which has been even more reliable.
In this situation, traders are probably better off not picking a side. We don’t have to trade every signal.
So, when two reliable indicators are conflicted, maybe we’re better off taking a pass on the trade.
Best regards and good trading,
Jeff Clark
Reader Mailbag
Are you going to pass on a trade due to the conflicting indicators? Do you find that the “crystal ball” has been a reliable indicator in the past?
Let us know your thoughts – and any questions you have – at [email protected].