One week later the S&P 500 was 100 points lower.<\/p>\n
The Predictive Power of the VIX<\/h2>\n
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.<\/p>\n
And right now, Volatility Index (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.<\/p>\n
You see, VIX options are not like most stock option contracts, which can be exercised at any time.<\/p>\n
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.<\/p>\n
For example, on Friday, the VIX closed at 12.93. At that level, the VIX February 14 $14 puts were intrinsically worth $1.07. But they were offered at only $0.85. That’s a $0.22 discount to their intrinsic value.<\/p>\n
If it existed on a regular, American-style stock option, you could buy the put, exercise it, and liquidate the position all day long – picking up $22 for every contract you traded. The European-style feature prevents that from happening – because you can only exercise the contract on the February 14 option expiration day.<\/p>\n
Because of this unique pricing structure, VIX options provide terrific clues about where most traders expect the VIX to be on option expiration day.<\/p>\n
<\/p>\n
Free Trading Resources<\/strong><\/p>\n 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 \u2013 at zero cost to you. Just click here<\/a> to check it out.<\/p>\n<\/p><\/div>\n<\/div>\n <\/p>\n Now, consider this…<\/p>\n On Friday, with the VIX trading below $13, the VIX March 20, $13 puts – which are $0.07 in the money – closed at about $0.30. Meanwhile, the VIX 20 $13 calls – which are $0.07 out of the money – closed at about $2.00.<\/p>\nHeading Down<\/h2>\n
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