Below are a number of charts which I believe offer some good insight to volatility and what is next for the markets. No magic bullet here, purely a play on the most probable outcome based on the chart patterns.

Vix VS Skew

I posted this chart on Thursday and a few had a hard time seeing the inverse correlation between the Skew and the Vix. Two important points I want to make with this chart.

Point 1 – look at the three red boxes showing the correlating trends (emphasis on trend). Notice the final red box and how the trend is lower (i.e. Vix higher).

Point 2 – notice how a similar divergence occurred between the Skew and the Vix right before a major jump in the Vix (now and where the arrow is drawn). That is why I say an imminent move higher in the Vix is highly probable.

 

The next three charts show a repeating pattern between now and early August before the big equity decline.

Chart 1

This shows the current divergence between the SPX and the Skew

Chart 2

This shows the same divergence on August 4, 2011.

Chart 3

This shows what the SPX did over the next two weeks.

 

Bottom Line

Take an 8% rally over 14 hours on nothing but short covering, a Vix due to pop, divergence on the skew and you have the recipe for a large move lower in equities. Again no magic bullet but the probabilities would say this is the most likely outcome.

Images: Flickr (licence attribution)

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