April 24, 2011

Another week is behind us.  The markets continued their march upward.  Here is the summary:

As you can see above, the major indices are all up for the week and options’ month. However, the VIX, the SPX volatility index is DOWN 40% since April 15, 2011, the end of the last options’ month.  This is something worth looking at since it may signal an upcoming market top and danger of a reversal. Take a look at the 5 year VIX chart:

As you can see in the chart, the VIX is at it’s lowest in over 3 years. Although it was lower than that in 2006 and part of 2007 (left 2 columns) this was BEFORE the mortgage and market fiascos.  Here is what the SPX looks like for the past 5 years, which generally is going the opposite of the VIX:

The red line, which is about 1345 – 1350 is the first obstacle the SPX will have to overcome to move higher. It was almost there twice in 2011 but in both cases it turned around. IF it penetrates that line (the red one) the next one will be the blue line, around the 1440 – 1450 mark. By the way, notice that both lines represent previous tops for the SPX.  Should the SPX get that far the VIX most likely will drop to the 2006-2007 lows.

For us, options’ and stock traders it is significant since low volatility (VIX) means low options’ premiums.  It is cheaper to just buy the options (low premiums) but as statistics show, most straight options’ buyers lose money. For those who do spreads, covered calls and occasionally naked puts, the lower premiums on SELLING the options makes it more difficult to trade on a shorter term, balancing the net lower premiums and the risk.

Let’s see what happens next week. I am very cautious at this point and keeping a close eye on both the SPX and VIX. By the way, it may represent an opportunity for us to open a position on both, taking into account that USUALLY both move in opposite directions.

Cheers

Erik

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