The Bulls Have the Edge This Week

The bulls have the edge this week.

The stock market often moves higher during the week of Thanksgiving. So, the seasonal winds are blowing bullish. Technical conditions are oversold – which should limit any potential downside action. And, the Volatility Index (VIX) generated a new, broad stock market buy signal when it closed back inside its Bollinger Bands on Friday.

The stage is set for a rally.

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 weeks. And, a lower VIX usually goes along with a higher stock market.

For example, yesterday, as the VIX was trading near $21, the VIX December 3 $21 calls were trading for $1.55. Meanwhile, the VIX December 3 $21 puts were trading for $1.70.

VIX put options are more expensive than the equivalent call options. This suggests the VIX will be lower on December 3 than where it is today.

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 December 24 $21 calls traded yesterday for $2.20 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 Christmas Eve 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 seasonal bullish tendency over Thanksgiving, the new VIX buy signal, and the current oversold conditions, traders making short-term bets on market direction this week should favor the upside.

Best regards and good trading,

Jeff Clark
Editor, Market Minute