The options market often reveals the truth about the
market….not talking heads.
Many self-directed investors turn to the major financial media
outlets…Bloomberg, CNBC, etc. when, in fact the options market
offers the most accurate picture of market expectations.
Over the past two weeks options traders have priced in higher
volatility, as the VIX
has climbed over 25% while the S&P 500 has moved
This same scenario has occurred before…right before the 1987
In mid-July 1987, the major market benchmark was making new
highs while the VIX was pushing to new lows. This is typically
how it works. The market goes up and the VIX goes down because
there is less fear in the market during rallies.
But by mid-August the VIX began to push higher while the
S&P continued to make new highs. Options traders and
investors alike had become fearful of a sharp decline as the
market seemed toppy at the time.
The VIX shot up almost 40% and soon after the market started
to collapse until the eventual Black Monday crash occurred.
But is this enough evidence to hit the panic button? Of course
This same type of scenario has happened 13 other times. And
the other occurrences were not nearly as catastrophic. Nine out
of the thirteen showed positive returns over the next six months
while the remaining four showed an average decline of -2.7%.
If you actually look at the options market going 6 months out
the chance of a normal 10% correction occurring is only 24%...
basically, a one in four chance. Over 20%... less than a 10%
Yes, a crash could occur, but I am not going to make
investment decisions based on anomalies. I am not going to
liquidate my account based on someone's opinion of a potential
market crash. I turn to the options market for realistic
probabilities and use strategies based on my assumptions.
I do agree that the market looks a bit toppy at the moment,
but I am not going to liquidate my account as a result. I am
going to use a strategy that takes advantage of a potential
decline…something like a bear call spread in the SPY.
Editor and Chief Options Strategist
The Strike Price