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Jeff Clark’s Market Minute: This Popular Trade Looks Dangerous

The VIX will much higher than where it is today

For the past few weeks, volatility has been declining.

Source: Shutterstock

The Volatility Index (VIX) closed recently at about 12. That’s near the lowest level of the year. And, speculators are betting that it falls even further.

But here’s what they’re forgetting… Periods of low volatility are always followed by periods of high volatility – and vice versa.

According to the most recent Commitments of Traders report released last Friday, traders have amassed a record high short position in VIX futures contracts. VIX shorts now exceed 200,000 contracts. That’s larger than the previous record of 193,000 contracts in January of 2018.

You might recall that back then the VIX traded below 10 – a sign of extreme complacency. And folks were placing big bets that volatility would remain low.

Folks were wrong.

Three weeks later the VIX closed above 37. The popular “short the VIX” trade got crushed. Heck, even one of the popular leveraged inverse-VIX funds was completely wiped out.

Fast forward to today, where the VIX is trading near its lowest level of the year and folks are aggressively shorting cheap volatility. That’s a dangerous trade.

Take a look at this chart of the VIX along with its Bollinger Bands

The Bollinger Bands (the blue lines on the chart) are pinching together. And, the VIX is trading near its lower Bollinger Band. It’s building energy for a big move.

This setup has happened twice before in 2019 (the red arrows on the chart above). Both times, the VIX was sharply higher a few weeks later.

Short positions in VIX futures contracts were fairly high back in April and July. But, they were nowhere near the level they’re at today. If the VIX does indeed start to move higher from here, then it’s likely to cause a lot of pain for those speculators.

I don’t think we’ll get the remarkable move we saw in early 2018. But, I suspect that by Thanksgiving – or perhaps even sooner – the VIX will much higher than where it is today.

Best regards and good trading,

Jeff Clark

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