April 21, 2011

The stock market keeps marching on. Below are 3 charts: the 1 year S&P 500 (SPX), CBOE SPX volatility Index (VIX) and VXX which is the VIX short term ETF.

As you can see in the above charts, normally  as the SPX rises the VIX, and therefore the VXX fall.

The VIX is at it’s lowest in more than 3 years (see 5 year chart below) and the VXX, being newer, is at its lowest ever.

Note what happened when the VIX went that low: It started to rise, meaning the SPX started to fall, and eventually exploded to the upside. It will happen again. When? I cannot tell you that but I can tell you that the danger level is now quite high.

For us options’ traders drastic declining VIX (volatility) means much lower premiums on options we try to sell, such as spreads, naked puts/calls and covered calls. Of course it makes it cheaper to BUY the options. However, with buying options we may be right eventually, but if we are not exactly right on the timing, no matter how cheap the options are (were), they will go down in value and eventually expire worthless.

Happy Easter everyone.

Erik Epp

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