Stock market bulls have enjoyed an amazing two weeks.

After selling off hard following the “Brexit” vote, the S&P 500 has put together a rip-roaring rally. The index has recovered everything it lost right after the vote. As of Friday, it’s sitting within spitting distance of a new all-time high.

[ad#Google Adsense 336×280-IA]But as amazing as this move has been, the market’s “crystal ball” says it’s going to end… soon. Let me explain…

Regular readers know one of my favorite indicators is the action of Volatility Index (“VIX”) option prices. This indicator has proven to be so accurate at warning of important turning points in the stock market that I refer to it as a crystal ball. And the crystal ball has just turned bearish.

You see, VIX options are European-style contracts – meaning they can only be exercised on option-expiration day.

This eliminates any possible “arbitrage” effect (the act of buying an option, exercising it immediately, and then selling the underlying security for a profit). So VIX options will often trade at a discount to intrinsic value.

For example, on Friday, the VIX closed at 13.20. At that level, the VIX July $14 puts are intrinsically worth $0.80. But they were being offered for only $0.40 – a 50% discount to intrinsic value.

If it existed as a regular American-style stock option, you could buy the call, exercise it, and liquidate the position all day long, picking up $40 for every contract you traded. (Remember, each option contract controls 100 shares.) The European-style feature prevents that from happening – because you can only exercise this contract on July’s option-expiration day (July 20).

VIX options provide terrific clues about where most traders expect the Volatility Index to be when the options expire.

Current VIX option prices tell us that traders expect the index to start moving higher soon.

As I mentioned, with the VIX at 13.20, the VIX July $14 puts – which have $0.80 worth of intrinsic value – closed Friday at $0.40. The VIX July $14 calls – which are $0.80 out of the money – closed at $1.20.

In other words, the VIX calls were at least 200% more expensive than the VIX put options. Traders are willing to pay 200% more to bet that the VIX will be higher July 20. And a higher VIX usually coincides with a falling stock market.

This sentiment is just as evident when you compare the VIX August $14 puts with the VIX August $14 calls. These options expire on August 17. The puts closed Friday at $0.40, while the calls were at $3.20. (I use my trading-quote system to track these prices, but you can find them here.)

Traders are willing to pay eight times more to buy calls on the VIX than to buy puts.

The last time we saw such a large price discrepancy was back in December when VIX call options were four times more expensive than the puts. The stock market fell 11% over the next six weeks.

Traders should prepare for something similar this time around.

Best regards and good trading,

Jeff Clark

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Source: Growth Stock Wire