The stock market’s “crystal ball” is flashing another warning sign.

Volatility Index (VIX) call options that expire this week and the next are far more expensive than the equivalent put options.

That means the VIX is likely to be higher in the days ahead. And a higher VIX usually goes along with a lower stock market.

A large difference in VIX option prices is often a good indicator for the short-term direction of the stock market.

In fact, it’s so accurate that we’ve dubbed this indicator the stock market’s “crystal ball.”

The last time we looked into the crystal ball was back in late March.

The S&P 500 had risen about 400 points in just two weeks. The CBOE Put/Call ratio showed that speculators were jumping all over themselves to buy call options and bet on a continued move higher. And TV talking heads were almost unanimously bullish.

But the crystal ball was screaming, “Be careful!”

The S&P 500 dropped 700 points over the next six weeks.

Right now, the crystal ball is flashing a warning similar to what we saw in late March.

VIX call options are much more expensive than the equivalent put options. Whenever this condition exists, the broad stock market is vulnerable to a sharp and sudden decline.

You see, VIX options are not like most stock option contracts, which can be exercised at any time.

VIX options are European-style contracts – meaning they can only be exercised on option expiration day. This eliminates any possible “arbitrage” effect (the act of buying an option, exercising it immediately, and then selling the underlying security for a profit).

So VIX options will often trade at a discount to intrinsic value.

Free Trading Resources

Have you checked out Jeff’s free trading resources on his website? It contains a selection of special reports, training videos, and a full trading glossary to help kickstart your trading career – at zero cost to you. Just click here to check it out.

Because of this unique pricing structure, VIX options provide terrific clues about where most traders expect the VIX to be on option expiration day.

And whenever there’s a large difference between the price of VIX calls and the price of the equivalent puts we can use it as a crystal ball for the stock market.

For example…

On Friday, the VIX closed at 24.64. The VIX July 13 $25 call options – which were $0.36 out of the money – closed offered at $1.20. Meanwhile, the VIX July 13 $25 puts – which were $0.36 in the money – closed offered for $0.60.

In other words, traders were willing to pay 100% more for a VIX call option that was $0.36 out of the money than for a VIX put option that was $0.36 in the money. This tells us that traders who are making bets on the VIX expect the index to move higher over the next few days.

This sentiment is even more evident if you go out a little further and compare the VIX July 27 $25 calls to the VIX July $27 puts. The calls closed Friday offered at $3.00, while the puts were only $0.90. (I use my trading quote system to track these prices, but you can find them at FreeRealTime.com.)

VIX calls are far more expensive than the equivalent VIX put options.

So, VIX option traders clearly expect the index to move sharply higher between now and the end of July. And a rising VIX (rising volatility) usually accompanies a falling stock market.

So, if you’re making short-term bullish bets, be careful…

The VIX “crystal ball” has a very good track record, and I bet it’ll prove correct this time as well.

Best regards and good trading,

Jeff Clark

Reader Mailbag

What’s your next move based on the crystal ball’s warning?

Let us know your thoughts – and any questions you have – at [email protected].