Stock markets touched new 52-week and year-to-date highs last week. Just before selling off in the last half of the week.

On the positive, most major North American indices managed to avoid slipping into the red for the week. But look at the late week sell-off, and combine that with the dip of 3-month US Treasuries into negative yield territory. US Treasuries rallied on Friday to end the week with a 0.02% yield. But not before trader talk tuned to risk-aversion.

Neither the CBOE Volatility Index (VIX) or the MX Implied Volatility Index (MVX) were signaling any imminent panic. In fact both indices fell, with the VIX ending the week at 22.19, and the MVX at 20.65. Both indices had been above 30 at the beginning of November.

Volatility indices traditionally measure fear and greed which, on the surface, suggests that traders are quite comfortable with current market levels. But that may be misleading. Volatility indices are much better at reacting to events than predicting them. If you are looking for a precursor to risk aversion, look to the Treasury market.

This is by any measure, a momentum driven market. Any sign that momentum is slowing, and traders will hit the sell button. Add to that possibility, the normal year end selling by institutions re-setting their portfolios for 2010, and I think there is a real chance of a large downdraft in a market that has been trending up since March.

Low levels on the volatility indices means that options are relatively inexpensive. Which means that buying puts on ETFs like the iShares Large Cap Index Fund (TSX: XIU, recent price $17.34), is prudent. Take a look at the XIU January 17 puts at $0.50 per contract.

Should the Canadian market experience a 10% correction between now and January, these puts will more than double in value. If the market does not correct, think of these puts as the cost of insurance that you did not need to use.