The recent slide in volatility has taken the VIX from a level of 32 down nearly 20, a more than 33% drop. That follows a rise of 50% from the same area in late October, so we're back to that mark. Is that a problem? Unfortunately for the bulls, the answer is YES. Today it may not be a problem, but the lack of fear is not going to propel much higher prices in the interim without the presence of volatility. After all, does the market go straight up and give everyone a profit? Of course not. The market seems to work best when there is some balance or even a slight 'edge' to the other side. For the bulls, the 'wall of worry' is what helps prices rise, while the bears exude confidence from the type of complacency we see today. Again, we are LOOKING for signs, which may appear sooner than you think. We play the game though until the rules or patterns change.
Might not be a bad thing to buy some volatility here as it's quite cheap.
Last week, I mentioned to our premium subscribers that the VIX was showing unusual behavior. It was unable to sustain a move above the important 23 level on Thursday and Friday, despite the market selling off.
This lack of any kind of fear spike in the VIX was interesting ... from one perspective, it could be viewed as complacency in the face of market weakness. However, as I've written previously, there is more and more "smart money" coming into advanced options trading. This means you dont automatically "fade the crowd" in a contrarian sentiment way, as was the common previous method. Another obvious factor in the VIX not rising is the common Thanksgiving holiday ... with the market closed Thursday and a half-day on Friday, Market Makers are looking to implode premium a bit.
A test of the key 20 level certainly seems to be in the cards (see the following chart) ... whether we stay above 20 on this week's closing basis will likely be an important sign:
VIX Daily Chart
The CBOE Volatility Index (VIX), which measures the implied volatility of S&P 500 Index (SPX) options, is a good measure of overall market expectations for volatility. As you may know, we hit record highs in the VIX over the past year, but have come down to the 20 to 30 area over recent months.
However since October we have seen the VIX make a mini-rollercoaster ride from the 30 area down to the 20 area ... then back up again to over 30 this month, and now we are heading back down lower, closing below 25 on Friday.
This recent volatility in the VIX itself has caused the Bollinger Bands on the index to widen considerably. As you can see in the following chart, the Bollinger Band Width on the VIX has reached its highest amount since January 2009. Certainly, that was a much more volatile time then now, before the March market bottom.
VIX Daily Chart with Bollinger Band Width
What does this VIX Band expansion mean? Well, this trend may not have peaked yet, but it does seem to indicate that there may be a large market move in the coming weeks/months (likely before year-end). What direction will we go? Well, the underlying trend since March is certainly bullish and liquidity is flowing into the world's markets like Niagara Falls ... but this is actually a big picture retracement rally within a bigger downtrend move. Additionally, we have run up over 50% since March, so one may presume that the current uptrend is a bit "tired". So I would lean to the downside, but the more concrete angle is to bank on a big move in either direction, utilizing your best technical analysis to determine what directional trend we are in or enter into.
It measures the implied volatility of S&P 500 Index (SPX) options, and basically gives an expectation of how much the SPX can move over a 12 month time frame. So for example, the VIX is around 23 today, indicating that index option traders are pricing in that the SPX could move up OR down 23% over the next 12 months.
The VIX is often studied and used as a sentiment indicator of fear or complacency among traders. It often is also used in a contrarian fashion.
Taking a look at the VIX Daily Chart below, you can see a clear correlation recently between VIX upward spikes and short-term market bottoms. Another key factor has been the VIX holding the 23 level on the downside. We are right around 23 currently. A confirmed break below 23 would likely be a bullish sign for the markets in my analysis ... while a hovering around here or a move higher would indicate the market will be range-bound with likely a slight downward bias over the short-term.
VIX Daily Chart
We mentioned the supposed large VIX upside July bets placed recently, and the following OptionVue data seems to belie the fact that some traders are placing bets on the VIX increasing its volatility (most likely betting on a big spike up):
As you can see on the following chart, the Implied Volatility on VIX Options is showing a big move up, reaching back to levels not seen since before the March 2009 market bottom. Remember that Implied Volatility of options is what makes up the "time premium" of option pricing and is human-controlled -- it rises and falls because of factors such as supply & demand and underlying statistical volatility.