Expecting a flash crash in the next 10 days

Still remember the one day flash crash a couple of weeks ago? You may consider this was just a random market fluctuation, it may not be so simple. Actually it was precisely “predicted” by some special traders. Let me explain.

You must have heard the volatility index, VIX, which has a nick name of fear’s index as it typically increases when the market drops with fears. VIX has its own options that traders buy or sell based on their prediction if VIX will go up or down. What’s is unique for the VIX option is that it is not an “American style” which allows for day trading. Rather, it is a “European style” that cannot be traded on the daily basis. It means, VIX options, when bought, can only be exercised on the option expiration day, not before. So why is this important for the “VIX prediction”? Well, traders cannot buy/sell VIX options for short term move expectation but they have to commit to holding them till expiration. In other words, it is based on their true “long term” belief which direction VIX will go in the next few weeks. You can imagine most of times, the calls (for up) vs puts (for down) are relatively balanced, meaning VIX is not expected to move sharply one way or the other. But from time to time, when traders are overwhelmingly betting for one side of move, you need to be careful. Believe or not, VIX traders have rather uncanny gut feeling with quite accurate predictability. Weeks ago before the May 19 expiration for VIX options, there was a huge imbalance (over 10 times) in favor of VIX calls, meaning traders were largely betting that VIX would have a huge move to the upside or the market would go down sharply. The market were very quiet with no fears whatsoever most of the time before May 19. Then all the sudden on May 18, VIX shot up 50% higher with S&P plunging nearly 2% in one day, wiping out all the gains in the previous months.

So what happens now with VIX options? Well, the VIX traders are sending another scary signal again. Right now, the VIX calls are over 15 times more expensive than the puts. They are telling us that VIX should sharply go up in the next 10 days till expiration on Jun 16. Of course, I don’t know exactly when and in what magnitude but I believe a sizable panic selling is coming pretty soon. Be careful if you are feeling happy now as a severe plunge could happen any day now!