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For some traders, it’s been their first taste of volatility.

At one point, it started to feel as if the market can continue higher — when traders are conditioned to buy and it doesn’t work to their favor…

They start to panic and get wamboozled by the market. The panic tends to subside, and the calm, cool, and collected traders tend to prevail. 

When it comes to volatility, there’s one gauge all traders look to, and some are saying there have been warning signs.

For me, I don’t try to listen to the talking heads and those who don’t have skin in the game. Instead, I focus on the price action…

And there are specific levels I’m going to keep my eye on, which can signal where the overall market is headed.

 

A Warning Sign… Or Just Fearmongering?

 

Traders are back to buy the dip mode, and the CBOE Volatility Index ($VIX) is pulling back today. Remember, one day does not constitute a trend and that’s why I believe it’s crucial to focus on the $VIX right now.

If you don’t know what the $VIX is, it’s the market’s indicator for expected volatility in a 30-day window.

When the S&P 500 rises, the $VIX falls, and vice versa.

With the CBOE Volatility Index between the 20-30 range, it’s an indication traders do believe volatility can pick up. With the $VIX breaking about 30 last week, it signaled there was fear in the market and traders may start to panic.

It’s been a pretty shaky few sessions, and that’s why I’m solely focused on the price action.

 

 

With the $VIX, I think it makes sense to fade volatility if it stays above February highs (around 3,400).

I think if those February highs hold, there are good risk-reward setups to fade volatility, such as. 

I think the $VIX will have a hard time trading above 45 and if it does, I have a harder time envisioning it staying there for too long. 

Rather than short volatility without hedging, with a bear call spread, the risk is defined and if volatility violently explodes… those who place a bear call spread will know their maximum loss.

The key levels I’m watching right now are 35 (a potential area to fade in the $VIX). If the market continues to bounce, I think the $VIX can break below 20 and maybe get back around the long-term average around the 13-15 range.

With a bear call spread, if $VIX collapses, then the premium would get sucked out and the bear calls would generate a hefty return.

 

 

Author: JC Parets

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