Last week, the stock market roared back to life.
After trading below 4200 the week before, the S&P 500 raced ahead and traded as high as 4530 on Friday.
Technology stocks led the charge as investors rushed to buy into Apple (AAPL), NVIDIA (NVDA), Google (GOOG), and other Wall Street favorites that had been discounted in the weeks before.
And speculators were once again jumping over themselves to buy call options and bet on the stock market continuing higher.
But the stock market’s crystal ball is once again screaming, “Be careful!”
The last time we peered into the stock market’s crystal ball was in December 2021 when it warned of trouble ahead – just before the S&P 500 fell 120 points in about a week.
So, with the market defying the new Volatility Index (VIX) sell signal and racing ahead anyway, it’s worth taking a look at the VIX option prices for clues as to where we go from here.
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.
And right now, 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.
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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.
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…
Last Thursday, the VIX closed at 21.67. The VIX March 30 $22 call options – which were $0.33 out of the money – Thursday offered at $1.65. Meanwhile, the VIX March 30 $22 puts – which were $0.33 in the money – closed offered for $0.80.
In other words, traders were willing to pay 100% more for a VIX call option that was $0.33 out of the money than for a VIX put option that was $0.33 in the money. This tells us that traders who are making bets on the VIX expect the index to move higher over the next week.
This sentiment is even more evident if you go out a little further and compare the VIX April 6 $22 calls to the VIX April 6 $22 puts. The calls closed Thursday offered at $2.59, while the puts were only $1.03. (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 April 6. 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. I’m betting it’ll prove correct this time as well.
Best regards and good trading,
Jeff Clark
Reader Mailbag
Last week, we asked Jeff Clark Alliance members about their recent gains on my new trading strategy. These are some of their responses…
I’ve been following the strategy and have been able to get in on some, and others were out of the range by the time I saw the order. But I thought I would share with you my results…
With INTC I held on a little longer and ended up with a 16% gain, and with CWH I actually missed the notice to sell and in less than a week got a 264% gain.
I wasn’t able to get in on the others. Sometimes I miss the notifications at work, or by the time I get them they’re out of the range. I appreciate all that you do. Thanks, and have a great day.
– Chad M.
Unfortunately, I was only able to get into one of the trades (UBER) and recorded a 43% gain in four days. Looking forward to doing more of these.
– Darcy L.
Joining Jeff Clark Alliance was one of the best decisions I’ve made to date. The newly released strategy that Jeff has employed has worked out for me thus far, capturing positive returns on every trade he’s recommended from this strategy. I look forward to seeing more types of these trades being coming forward in the future.
– Joshua B.
With CPB I exited early for a 48% gain.
– Donald W.
Thank you, as always, for your thoughtful comments. We look forward to reading them every day. Keep them coming at [email protected].