VIX is worrysome

Alright, so the bulls pulled one out of the fire. I would have been inclined to fade that opening down for a quick trade if I wasn’t so busy soothing my cranky daughter. With the market oversold as it is, it's usually a good risk/reward set up to fade morning weakness like that for at least a quick intraday trade. Intraday trading is not my style but there are times, like now, when emotions are running high that good intraday opportunities present themselves.

But on the grander scale of things, I don't think we've seen the lows of this move. A big reason I feel why is the VIX. Despite the weakness we've seen it only got as high as 29 intraday before quickly retreating. Every decent bottom this year and other years as well has been preceded by a spike in the VIX of some sort. Instead, this time around the VIX has been slowing turning up, grudgingly rising when the market goes down but rather easily falls on days the market goes up just modestly like today. I've seen this happen before in the past and it's been a bearish sign. It shows a lack of fear, which is odd because I also see plenty of clear signs of high pessimism.

One indicator that is never talked about is the VIX futures curve. If you look at VIX options they are priced based upon this curve. What it can tell you is the expectation of future volatility is by the market. When the futures curve is steeply sloped it indicates expectations of volatility rising in the future (i.e. the VIX going higher in the future) and when the VIX goes higher markets go lower (the vast majority of the time). I have found the VIX futures curve to be a smart money indicator. It doesn't however give you precise timing. For instance the VIX futures curve was steeply sloped in early December and early March but it took well over a month in both cases before the market rolled over. So, basically when it's steeply sloped it's indicating that any rally in the market is on borrowed time. At ST market bottoms the opposite happened. The VIX curve became inverted.

Currently the VIX futures curve steeply sloped and has been so since mid July. This is how you can see what I'm talking about. Take a look at VIX options that expire in 3 or 4 months and look at the value of the call and put that have the strike price that is closest to the spot value (current value) of the VIX. For example, look at the call and put values of November VIX options with the 26 strike. The call is asking 7.6 while the put is only asking 1.1. The call is 7 times more expensive than the put even though the strike price and spot price are about the same! What this means is that VIX traders expect the VIX to rise substantially in the future thus the reason for the expensive calls. I've been watching the VIX futures curve since November of last year and it's been right every time. Again, the timing is not precise when it comes to market tops but when it's giving a warning signal it tells you the rally is on borrowed time and so if you went short you would have felt pain for a while but would have been rewarded eventually. On the other hand it has been pretty good timing bottoms (when the curve gets inverted and the puts trade at a substantial premium to calls of the same strike).

So, if VIX option traders expect a substantial rise in the VIX, it pretty much means that they expect to see the market have a sharp drop down still ahead. Now, you should never hang your hat on just one indicator but it's been pretty damn good since I've followed it. Even if you disregard all this VIX futures curve mumbo jumbo, we haven't seen any kind of spike in the VIX and it's plain to see with the naked eye that every meaningful ST or IT bottom in the past year and even further has had such a spike. The absolute number of the VIX isn't so important....it's the spike behavior that is.

Sure, we're oversold and it wouldn't be much of a surprise to see more of a bounce as traders play the game of chicken, but the VIX behavior is a big holdout here for me to be able to say go "all in" long, turn off your computer and go travel the world for a few months. That's really the type of moment I've been waiting for all summer long. Until then I will try to be nimble and opportunistic with quick trades.

Aside from VIX issues, bulls need to be careful because the economic data has now clarly rolled over which gives the "fundamentals" edge to the bears. Yes, earnings are still robust but they they are more of a co-incident indicator not a leading one. Eventually the market will get to the point where it's sold out having discounted the worst and no longer reacts poorly to such negative data points (at least for a while). There's no solid evidence to suggest this has happened just yet. One day doesn't make a trend and we did not reach extreme oversold levels on a technical basis not to mention a lack of a VIX spike....I know, I know shut the fuck up with this VIX talk already.