Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

A Vexing Message From VIX Options


It seems the pieces are in place to climb a wall of worry and take the market back to the top end of the range again.

While overall equity volume has been lacking on this recent rally, option activity is running some 18% above the 30-day daily average and it's not all due to tomorrow's impending expiration. The S&P 500 Index options (SPX) have already traded 300,000 contracts or some 25% above average. And while the February expiration does cease trading this afternoon -- which would generate some closing transactions -- the fact is, the most active strikes are in March.

The 1225 strike is the volume leader with 47,000 contracts traded which follows yesterday's volume of 26,000 contracts, nearly all of which translated into new open interest which now stands at 52,000 contracts. Most likely this is part of a larger position or a form of a hedge. But still, scooping up calls some 120 points or nearly 11% OTM suggests someone is scared of a melt up. Or maybe it's just a way to keep the margin requirement down on a larger bearish position.

As far as sentiment gauges got, they're presenting a somewhat mixed picture. The VIX, which measures the IV of SPX options, actually dipped below the 10-day historical volatility for the first time since last November. This was the result of real volatility jumping to around 25% as the market enjoyed several days of 1%-plus price moves. The VIX and its futures suggest that traders believe that volatility will decline somewhat and revert to the mean over the next 30 days.

In fact the put/call ratio on the options for the VIX futures has climbed to 1.10 this week. That's the highest reading in over four months. It suggests that traders are buying puts on the VIX in anticipation that volatility will decline in over the next two months.

This expectation for a decline in volatility seems to stand in contrast to the broader put/call ratio which has been running near four-month highs suggesting that investors have been buying put protection to brace for a sell-off. In fact the ISEE -- which is a call/put ratio and a better measure of investor sentiment in that it only uses opening or new purchase transactions from retail accounts in its calculation -- has been declining the past two weeks even as the market has enjoyed a healthy 5% bounce off of the 1050 low the S&P made on February 5. The ISEE now stands at 105, its lowest level (most bearish) in eight months.

This indication of investor worry seems to be consistent with other sentiment indicators such as Investor Intelligence bull/bear data in which the latest reading this week showed a solid 27% still residing in the bear camp and a full 40% expecting a correction. Again, this comes after we've already had a 10% correction and the ensuing 5% rebound.

All in all, it would seem that we have the pieces in place to climb a wall of worry and take the market back to the top end of the range again.

For more from Steve Smith, take a FREE 14 day trial to OptionSmith and get his specific options trades emailed to you along with exclusive access to his full portfolio. Learn more.
< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Featured Videos