Look Out for a Decline

The crystal ball has changed its mind. VIX option prices have turned bearish.

As we explained last Tuesday, VIX option prices can provide clues as to the short-term direction of the stock market. When VIX call options are trading for a much higher premium than the equivalent put options, the VIX will often move higher. And, a rising VIX usually goes along with a falling stock market.

On the other hand, when VIX put options are priced much lower than the equivalent calls, traders are looking for a lower VIX – which usually goes along with a rising stock market.

Last week, we noted the VIX put options were higher priced than the VIX calls. So, we were bullish. And, that bullishness played out with the broad stock market closing higher every day.

Now, though, we have the opposite condition.

Yesterday, as the S&P 500 was rallying in the morning, the VIX was trading at 16.50. The VIX December 10, $17 calls – which expire one week from Wednesday, and is $0.50 out of the money – was priced at $1.40.

Meanwhile, the VIX December 10, $17 put – which had $0.50 of intrinsic value – was only $0.35.

In other words, traders were willing to pay four times as much for out-of-the-money VIX calls than for in-the-money VIX puts.

The condition was just as extreme going out to Christmas Eve. The VIX December 24 $17 calls were trading for $2, while the equivalent VIX put options were only $0.55.

When we’ve previously seen this type of pricing structure in VIX options, the VIX has often moved higher in the short term.

This is the opposite of the condition we were looking at last week. Back then, the crystal ball was bullish. We were looking for a rally. And, that’s exactly what we got.

This week, though, the crystal ball has turned bearish. So, it’s probably a good time to be looking out for a decline.

Best regards and good trading,

Jeff Clark
Editor, Market Minute