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Nearly three months have passed since we last peered into our crystal ball. The “military conflict” in Iran was just starting. Stocks were selling off on the news. But, our crystal ball told us it was time to buy.
So now, with the broad stock market trading at all-time highs, and with the military conflict coming to an end it’s probably a good time to take another look into the crystal ball.
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 higher VIX over the next few days, and the next few weeks. And, a higher VIX usually goes along with a lower stock market.
For example, yesterday, as the VIX was trading near 16.60, the VIX June 2 $17 calls were trading for $2.00. Meanwhile, the VIX June 2 $17 puts were trading for $0.25.
In other words, VIX calls – which were $0.40 out of the money – were trading for eight times the price of VIX puts, which were $0.40 in the money.
VIX call options are much more expensive than the equivalent put options. This suggests the VIX will be higher one week from now than where it was yesterday.
This is an extreme price difference. When we’ve seen this condition before, it has usually resulted with the VIX moving higher and the stock market moving lower in the short term.
If we go out a bit further in time, the picture is just as bearish. The VIX June 24 $17 calls traded yesterday for $3.50 while the equivalent put option was $0.35.
Traders were willing to pay 10 times the price to bet on a higher VIX by the end of June than they were to bet on a lower one.
There’s no question the crystal ball is leaning in the bearish direction.
Add to this the potentially explosive setup in the VIX chart we pointed out last week and you have the setup for a stock market decline that will catch most traders by surprise – or, at least the traders who don’t know how to use the crystal ball.
Best regards and good trading,
Jeff Clark
Editor, Market Minute