According to the futures report from Bloomberg (as of 10:56pm pst), the market looks like it may continue the rally tomorrow that it built on today. The DJIA and S&P futures are UP 17 and 5 points, respectively.  Good news?  Perhaps.  But just because the futures look good prior to the markets open does not mean the marekts will remain in positive territory through the trading day tomorrow.

One potential red flag for a possible market blood bath tomorrow is the open interest in the October 90, 95 and 100 strikes on the volatility index (VIX).  Since 2000, and prior to 2008, the VIX had only breached the 50 mark twice.  The first time was immediatley following the 911 attacks, and the second time was in the summer of 2002 due to the uncertainty and fear after Enron’s collapse.  WIth the credit crisis of 2008, the VIX has already set several new records, including today when it surpassed 80 for the first time in history.

In general, the VIX increases as the market’s head down and decrease as the market recovers.  But it takes way more than a mild downturn for the VIX to reach beyond the 50 mark.  And each subsequent 10 point increase in the VIX - to 60, 70, 80, etc - requires an even more severe market downturn.   In order for the traders who bought those October 85 and higher strikes in the VIX to make money, it is going to take one hell of a bloodbath in the markets tomorrow.  Do they know something we don’t know?  Sometimes money in the market spells solid rumors in the street.  And if the traders that placed those bets on a high volatility spike for tomorrow are right, then we may definitely see one hell of a blood bath in the markets tomorrow as the VIX reaches for par (100 mark).

Let’s hope they are wrong…

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