Is A Selloff Coming?

| October 3, 2014 | 0 Comments

After last week’s relatively steep selloff in equities, investors are becoming concerned a larger pullback is in the works.  After all, it’s only natural when the selling starts to assume more is on the way.

But what are the options markets telling us?

Keep in mind, the smart money often likes to use options rather than stocks.  Not to mention, options are where most investors go to hedge their long positions.  As such, options activity can give you sound insight (at times).

In this case, let’s just stick to the most basic options indicator, the VIX.  The CBOE’s S&P 500 Volatility Index is often considered the market’s fear gauge.  It tends to show when investors start worrying about a broad-market pullback.

Here’s the thing…

The financial media loves to point out large percentage jumps in the VIX when stocks go down.  Yes, the VIX does tend to move in gaps.  That’s the nature of volatility.  But who really cares about percentage moves?  What’s important in the VIX is the actual level.

For instance, despite the tough week for stocks, the highest the VIX closed was at just 15.64.  Over the last three years, the VIX average has been 16.7.  In other words, we haven’t even climbed to average volatility levels during this recent selloff!

Now, the VIX isn’t the be-all, end-all metric for volatility.  The index could go from 15 to 20 to 30 in a matter of days.  But, judging by the current level of options activity, traders aren’t predicting a major selloff is in the works.

One thing to consider, large caps have held up a lot better than small caps and momentum stocks in the recent pullback.  

You see, the VIX is based on the S&P 500, so while it does a good job of reflecting overall investor sentiment, it is certainly more focused on big companies.  If you were to look at volatility in the Russell 2000 (small caps) or the Nasdaq Internet Index, you’d certainly see a different picture emerging.

Once again, this development doesn’t suggest a correction is coming.  It’s just another data point to consider.  Investors could simply be in “risk on” mode for the time being.

Basically, keep a close eye on the VIX, but don’t rely on it solely.  It makes good sense to pay attention to what other major indices are showing as well.

Yours in Profit,

Gordon Lewis

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Category: Options Trading

About the Author ()

Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also one of the key analysts behind the highly successful Options Trading Wire and Advanced Options Adviser. As a market maker on the floor of the CBOE, Gordon analyzed and traded stocks and options across a broad range of market caps and industries including retail, internet, oil, insurance, and telecom. He often traded thousands of options contracts per month… and it’s fair to say, Gordon’s analyzed and invested in some of the most complex and successful options strategies in the world.

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