Editor’s note: For today’s Market Minute, we wanted to share an educational piece on one of Jeff’s favorite ways to predict market moves. It’s an idea you should take advantage of right now… and works even better in today’s volatile market than it did a year ago, when this piece was first published.

Look for a new Market Minute tomorrow morning… and read to the end of today’s issue for an important update.

In today’s Market Minute, I’d like to share an idea that can make you a better trader.

It’s the one indicator I follow more than any other when I want to know where the stock market is headed next. It’s a twist on a commonly followed market indicator… the Volatility Index (VIX).

The VIX is a measurement of fear in the marketplace.

A high and rising VIX indicates that investors are scared and traders are bearish. A low and declining VIX indicates that investors are bullish and traders are complacent.

The VIX is a good contrary indicator, and it does help warn investors that the market is at extreme levels and vulnerable to a reversal. Some traders even refer to the VIX as a “crystal ball for the stock market.”

That’s a bit of an exaggeration. You see, the VIX does flash caution signs when the market gets a little too overheated to the upside or the downside. But the VIX doesn’t tell you how soon those trends are going to reverse.

So, trying to time a trade by watching the VIX is like driving on a road where the stoplights are timed inconsistently. One light might be yellow for five seconds before it turns red. The next light stays yellow for 20 seconds. Then the next light might stay yellow for four minutes. It’s hard to drive on that kind of road. And it’s hard to trade by just watching the Volatility Index.

But watching VIX options, on the other hand… well, that’s a better crystal ball.

VIX options are difficult to trade. The half-dozen or so times I tried were all disappointing. It didn’t matter if I got the direction right. It didn’t matter if the VIX moved far beyond my upside or downside targets – it is remarkably difficult to profit trading options on the VIX.

But watching them trade can make it far easier to profit on the rest of the stock market.

Let me explain…

VIX options are European-style contracts – meaning they can only be exercised on option expiration day. This eliminates any possible “arbitrage” effect (the act of buying an option, exercising it immediately, then selling the underlying security for a profit). So VIX options will often trade at a discount to intrinsic value.

For example, on Tuesday, April 25, the VIX closed at 10.76. At that level, the VIX May 17 $12 puts were intrinsically worth $1.24. But they were offered at only $0.60. That’s a $0.64 discount to their intrinsic value…

If it existed on a regular, American-style stock option, you could buy the put, exercise it, and liquidate the position all day long, picking up $64 for every contract you traded. The European-style feature prevents that from happening – because you can only exercise this contract on the May 17 expiration day. But we can still benefit…

VIX options provide terrific clues about where most traders expect the VIX to be on option expiration day.

The current VIX option prices tell us that even traders who are making bearish bets on the VIX expect the index to move higher in May. This sentiment is even more evident if you compare the VIX May 11 calls to the VIX May 11 puts. The calls closed Tuesday, April 25 were offered at $1.50, while the puts were only $0.15. (I use my trading quote system to track these prices, but you can also find them here.)

So, VIX calls are trading for 10 times the price of the equivalent VIX put options.

VIX option traders clearly expect the index to move higher in the short term. And a rising VIX (rising volatility) usually accompanies a falling stock market.

Watch the VIX for signs of investor fear or complacency that can lead to a trend reversal.

But pay closer attention to VIX options. They’ll improve your timing on reversal trades.

Best regards and good trading,

Jeff Clark

P.S. In all the volatility that’s marked this year, I’ve been developing a new method of trading in hostile market environments.

I’m planning something big for it… which you’ll start hearing about later this week. Stay tuned.

Reader Mailbag

Today, a few words from a Delta Report subscriber…

I was an ardent follower of Jeff’s Short Report for years and I will say that I’m impressed with the progress and level of communication he’s offering with his new service.

– Ellen

Some plans for the rising buck…

My plan is to let the dollar run higher and follow your lead. When you indicate you believe it has run its course, and if gold and/or silver are still lower like they are now, I plan on selling a couple of GC and/or SI naked July futures puts at the money and let the time value erode and the premium decline as they push higher as the dollar drops or stops rising.

Two ways to win. Dollar holds steady (win on the time), dollar drops (win on time and price). With the premium, the price of either can drop and I still have some cushion due to the time value of the naked puts. This can apply to futures, gold or silver ETFs or leveraged ETFs, miner ETFs, or leveraged ETFs. It can also be applied to naked DUST calls.

– Gary

And a trade idea…

Jeff and trader family, I just noticed the UPS chart had a great Sledgehammer trade – was perfect to buy four weeks ago, and has now fulfilled its promise. The Sledgehammer for MMM has fallen 3 levels already, could be a good buy soon.

I see another perfect Sledgehammer stock that is perfect to buy right now, I’m greedy, so won’t reveal it!

– Jim

Thank you, as always, for your thoughtful insights. Keep them coming right here.

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