If the market’s crystal ball had shoulders, it would be shrugging them right now.
One of my favorite indicators offers no clue as to where the stock market is headed next.
So, that means we’re probably in for a lot of choppy action over the next two weeks.
Let me explain…
Long-time readers know I look at Volatility Index (VIX) option prices as sort of a “crystal ball” to determine the immediate direction of the broad stock market. And, this crystal ball has a nearly flawless track record.
Without getting into the intricate details of VIX option pricing, the basic theory is that when VIX call options are far more expensive than the equivalent put options, the VIX is most likely headed higher.
And, since a rising VIX usually goes along with a falling stock market, this condition is bearish for stocks.
Whenever VIX put options are far more expensive than the equivalent calls, the VIX is likely headed lower. That condition usually accompanies a rising stock market.
So, traders who are looking for clues as to the short-term direction of the market can usually find it by paying attention to VIX option prices.
Right now, though, the crystal ball isn’t offering any clues…
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When the VIX was trading at $20 yesterday, the VIX October 20 $20 calls – which expire next week – were trading for $1.20. The VIX October 20 $20 puts were trading for the exact same price. In other words, the VIX options were not favoring a move in either direction.
The same was true for the VIX options that expire on October 27. The VIX $20 calls and puts were both trading for about $1.50.
We’d have to go out to the November 3 expiration date before we saw much of a price differential. For that expiration date, VIX calls are about 80% more expensive than the equivalent puts.
So, that’s something to keep in the back of our minds – and be aware of the possibility of market weakness as we roll into next month.
But, for the next two weeks, the crystal ball suggests the stock market isn’t going anywhere.
That doesn’t mean we won’t see big moves in one direction or the other. Heck, the VIX is sitting near 20 – which is an elevated level – so were going to see some volatility. But, whatever big moves we get one day are likely to be reversed the next.
That is, of course, what we’ve been seeing for the past couple of weeks… The market falls one day, and then bounces back the next. The market rallies on the opening of trading, and then sells off by the close.
The market has been a choppy mess for most of the month. And, according to the crystal ball, it’s likely to stay a choppy mess.
So, how do you trade it?
Keep your positions small. Trade only the best, highest conviction setups. And, take profits quickly because just about every big move in the broad stock market will reverse – at least for the next two weeks.
Best regards and good trading,
Do you rely on the “crystal ball” to calculate your next move? If so, do you usually see big gains?
Let us know your thoughts – and any questions you have – at [email protected].