As I mentioned yesterday morning to our clients, our momentum-based VIX signal has us avoiding new short volatility and long stock positions for the moment. If we see some additional large swings in the CBOE Volatility Index (VIX) over the next few days, a volatility-of-volatility estimate I follow will also signal a ratcheting down of exposure.
We can also look at the order flow in major index option products on Tuesday to gain some clarity about market sentiment.
fig. 1. VVIX, 2012. Source: CBOE, Condor Options
First, notice that the implied volatility in VIX options jumped to levels we haven’t seen since late August (fig. 1). Anecdotally, this seems to indicate that traders are taking these selloffs more seriously than they were last week. At the same time, we shouldn’t read too much into one data point. At about 460,000 contracts, VIX option volume on Tuesday was right in line with its average daily volume, so it’s not as if investors were piling into VIX calls en masse. Additionally, it’s worth noting that traders were net sellers of VIX option premium, selling twice as much premium in puts as was bought in calls. The overall directional tone was still positive, indicating a bias toward more upside for VIX and downside for the S&P 500.
The order flow in SPDR S&P 500 (SPY) and SPX options was a bit less routine. SPY volume was 40% higher than normal, with trades directionally slightly positive but heavily tilted in favor of buying premium. The same goes for SPX: volume was up 30%, the delta bias was positive, and traders were net buyers of premium to the tune of $58 million.
This kind of activity has the feel of a market that rushed in during the morning to apply some portfolio hedges, happily paying a higher premium to protect recent gains. On a contrarian basis, many traders look for signs of index-level capitulation before committing fresh capital to long positions, and so far we haven’t seen evidence of that kind of panic.