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Four Reasons Why the VIX Is Looking Bullish


Real divergence could mean real gains.

I've seen a couple pieces lately noting the "divergence" in the VIX this week, such as this one from Bespoke, for example. Hat tip: Abnormal.

"While one measure of volatility recently made a new short-term low, the VIX volatility index recently failed to take out its recent lows and is now trading back above 30 even when the overall market has made new short-term highs. This failure to head lower has some investors looking for a pause in the rally, as fear of a pullback seems to be creeping back into the market."

As I often note, you should pay the most attention to the VIX when it does the unexpected. However, this is a poor interpretation - and from a few different angles.

1. VIX is a contra indicator. VIX divergence of this kind is actually a bullish signal; it shows fear has increased.

2. But that belies the point that you can't get carried away with absolute numbers in the VIX. It's a statistic, not a stock. I can't emphasize that enough. Support and resistance are shaky constructs here.

3. In this particular example, it fails to account for the calendar. If (when) you buy my book, you will find a chapter dedicated to breaking down the expiration cycle. Options volatility tends to statistically trough early in the expiration cycle. This is especially true in a 5-week cycle, and even more so when you have a holiday on the horizon. And that's exactly what we saw 2 weeks ago; the comparison point to this cosmic divergence. Throw in the fact that the market itself was strong and you had a perfect storm for pressure on options.

4. In fact, I show average VIX readings (adjusted for day of the week) about 7% higher about here in the cycle than a couple weeks ago. In other words, all things being equal, options should trade higher now. So in my humble opinion, there's nothing too abnormal about the current options pricing.

And again, if there's actually real divergence, it's bullish for the market, not bearish.

Just for the record, adjusted options volatility tends to peak early in the second-to-last week of the cycle.
No positions in stocks mentioned.
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