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March 21, 2013  Thu 8:56 AM CT

VIX: SEE CHART GET CHAIN FIND STRATEGIES
Stocks are at highs, volatility is low, and all is well in the investment world ... right?

Certainly there is wisdom in not fighting the tape, and picking tops is typically a losing game. But there are warning signs in the data that I follow.

This doesn't mean that I am bearish, but it does mean that I am nervous. And clearly I am not alone.

Granted, the CBOE Volatility Index is low. On Tuesday it rose to 15, but yesterday it fell back below 13. The VIX was around 11 last week, its lowest since February 2007 and well below its long-term average around 20.

However, the current level of expected volatility is still twice S&P 500's 10-day historical rate of 6 percent. The VIX futures are indicating even higher levels, with April futures at 14.50 and the May contracts at 15.60.

We can also factor in the CBOE SKEW Index, which measures the relative cost of out-of-the-money SPX puts to calls. It is always above 100, but it began yesterday's session at 127 as it remains near all-time highs. The SKEW was this high in September 2012, March 2012, and late April 2011--all relative highs for the SPX. 

But one thing that makes me nervous is the volatility of the VIX itself. Yes, it may seem comical to analyze the volatility of the volatility index, but it does makes sense.

The VIX spiked higher by 37 percent from Friday's lows to Tuesday's highs when the SPX was down just 1.6 percent. Some of that may be attributable to a statistical quirk in the calculation, but the March VIX futures were up 23 percent as well, so there was real sentiment behind the move.

The recent action has pushed the 20-day historical volatility of the spot VIX up to 166 percent. The last two times it was this high, the volatility index broke above 45.

All of this suggests that traders have a hair-trigger mentality right now, even more than usual. Hedge funds are carrying a high level of short-volatility positions, as discussed in previous columns, and that may be one reason for the skittishness as it raises the possibility of a huge squeeze.

On Tuesday the SPX saw a very small move at the end of the session as it gave up less than 4 points. But it was a record volume day in the VIX options and the third largest day for the VIX futures. Yesterday's session may have surpassed both of those milestones. 

For most of the last 18 months, any selling in the S&P 500 has been met with buying, especially since mid-November. But selloffs are a natural and necessary part of the market. So when the next one comes it could be more violent, and that is what the volatility of the VIX suggests to me.

Last week I stated that, if I were a betting man, I would put some money on the SPX running to new highs and then pulling back sharply in the near term. I was wrong on both counts, but only barely. And I still see that scenario as distinctly possible in the near future.

(A version of this article appeared in optionMONSTER's Options Academy newsletter of March 20.)

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