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Almost There


If you look at a chart of the VIX index, a rough estimate of implied volatility, it looks very much like a broken stock. But it isn't a stock; it has no fundamentals. It is most closely related to sentiment and even though sentiment comes in extremes, it is always cyclical: a very low level may go lower, but at some point it will come back. The levels clearly indicate complacency, extreme complacency. The option flow I have seen confirms this: I have seen an overwhelming supply of options. From selling upside calls to downside puts, no one seems to want to own options here.

The first wave of selling comes from those that are long options and sell because they are losing money. The second wave comes from those that short options, thinking there is money to be made because the market of stocks will move little. This second wave is where leverage in the market is built up. This is where I think we are now.

What I am waiting for from here is a pick up in the VIX (I don't really use the VIX, rather baskets of other options; but they are highly correlated and they are confirming each other). When it begins to turn up, that to me is a signal that some very smart buyers who have good information are beginning to buy options. I started to see it yesterday, but so far today the VIX has trailed back off. This signal is one of the best I use and is almost always a bearish one. It won't catch the top, but it is good at catching a sustainable trend lower. We are almost there.
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