Yesterday the VIX sank to its lowest level since late July. That has us wondering, given everything that’s transpired the last few months, is the market complacent? We’re surprised by how low the VIX is but there are two ways to interpret it:
1.) The VIX slumping is a sign that the market will be on much more stable ground to start 2012
2.) Traders/investors are not prepared for a spike in volatility and are going to be caught blindsided if one shows up
To decipher these two thesis’s we analyzed the premiums on VIX contracts expiring January 18th, 2012. We’ll choose 3 strikes on the call and put side to focus on: 23, 25, and 30. On the call side the 23 strike is going for $4.70, the 25 for $3.30, and the 30 for $1.65. Based on the current price of the VIX (23.22) those strikes are factoring in a premium (the amount the VIX needs to rise in order for these calls to break even) of 19%, 22%, and 36% respectively.
On the put side the 23 strike is going for $0.75, the 25 for $1.55, and the 30 for $4.90. Based on the current price of the VIX those strikes are factoring in a premium (the amount the VIX needs to fall fall in order for these puts to break even) of 4.1%, -1%, -8%. Yes you are seeing that correctly, there is actually negative premium being factored into the 25 and 30 put strikes. That means as long as the VIX doesn’t rise 1% and 8% in regards to each respective strike, then they will at least break even.
As you can see, there is significantly much more premium being baked into the call side vs the put side. There are a number of arguments one could make as to why this is is:
1.) options players don’t see much more downside in the VIX so why would you want to buy puts on it
2.) options players are looking for a huge spike in the VIX, so while it is low there is still alot of premium being factored in because of the volatility we’ve seen the last few months; just because the VIX is cheap doesn’t mean it is cheap to own
3.) big funds are stepping back into the market and they are buying calls on the VIX to hedge newly initiated long positions
4.) if the VIX is low then that means the ratio of calls/puts being purchased on the S&P500 is in favor of the calls — shorts are buying calls on SPX to hedge new or already existing short positions
So which interpretation is the right one? Technically there is no way of knowing until the market reveals its hand. But we can make an educated guess. We would say that given the extreme volatility we’ve since August and over the last few years in general (flash crash, 2008-2009 financial crisis, etc…) there’s no way market participants are stupid enough to go into 2012 not expecting volatility. After all, volatility has been the one rare constant in this market over the last 3 years.
So with that being said, we feel as though there is a great battle going on between the shorts and the longs right now. The bulls scored victories on days like Tuesday and 11/30, when the Dow rose over 300+ and 500+ points, respectively. And while the bears haven’t managed a 300 point down since 11/9, the overall trend has been lower (see the lower highs put in place since 10/28). So in this case we defer to the power of the overall trend. Until we see a breakout above the October highs in the market the bears deserve the benefit of the doubt and we recommend shorting the market going into 2012.
Did you know that you can watch Stockhaven trade live in real time?
Learn how to daytrade by watching someone else trade! Watchhimtrade.com is the only site that lets you look over the shoulder of a professional daytrader.
Watch this video now where he shows you how it’s possible to make 100% in just 5 minutes!
Related posts:
