A development in the derivatives market for the VIX — an estimate of implied volatility of S&P 500 options commonly known as the “fear gauge” — suggests the sell-off that has gripped the stock market over the last two trading sessions may be coming to an end.
Dave Lutz, head of ETF trading and strategy at Stifel Nicolaus, points out that the 3-month VIX curve has dipped into backwardation. In other words, near-term VIX futures have now become more expensive than longer-term VIX futures, suggesting traders are betting that volatility in the future will be lower than it is now.
“When this happens on a CLOSING basis, we have seen sharp short-term rallies over the last year,” says Lutz.
“Why? Too much near-term stress has built up, pushing the cost of protection for today higher than the cost of protection 3 months from now.”
The chart below shows that when the VIX curve goes negative (blue bars), the S&P 500 (red line) tends to rally. Barely visible at the far right of the chart is the small dip below zero that has occurred today.
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