Will Volatility Continue to Flatline?
- The VIX Index has no pulse.
- Is this celebrated indicator DOA?
- Or is it about to awake from its slumber?
- Also recommended: Nothing drives a stock higher or faster than this…
So the VIX has flatlined.
It’s been meandering along in a sideways direction for nearly four years.
In fact, the four-year chart of the VIX looks like an electrocardiograph (EKG) of a recently diseased person.
Sure, you’ll see an occasional blip.
But not even a dead person has a ruler-straight EKG line.
Sorry, folks — that long, continuous “flatline tone” when you die is mostly a Hollywood fabrication.
I’m covering the VIX today because it was once a key contrarian indicator.
Perhaps it’s time to announce this patient as dead, though.
Let’s check the vitals…
Also known as the “fear index,” the VIX measures the volatility of the S&P 500.
High VIX levels (above 20) suggest a fearful market.
Fearful markets represent great times to buy.
Low VIX levels (below 20) speak to a complacent market.
Complacent markets represent great times to take some profits.
Generally speaking, the VIX climbs about 4% for every 1% fall in the S&P.
The last notable upward blip on the VIX came in September 2015 as the result of a dovish Fed announcement. And it barely moved the S&P’s needle.
I asked my senior analyst, Martin Hutchinson, a simple question…
Hutch’s full report is below.
Ahead of the tape,
Chief Investment Strategist, Wall Street Daily
Martin Hutchinson: Today I’d like to talk about the VIX — the Chicago Board Options Exchange Volatility Index — and how it’s useful to investors.
VIX shows the market’s expectations of 30-day volatility. It’s a measure of how much the markets are expected to bounce around in the next 30 days.
It calculates the weighted average of implied volatility of eight Standard & Poor’s 500 index options.
What’s implied volatility?
You take the price of the options and shove it backward through the Black-Scholes options valuation model and out spits the implied volatility.
Usually you use the Black-Scholes model to start with volatility and end up with a price. Here, you’ve got the price and you want the volatility, so you feed it through backward.
Note that the implied volatility is the market’s forecast of volatility. It doesn’t actually represent real volatility or what the volatility’s going to do. It’s merely what options prices think volatility will be.
The VIX is around 10–15 in calm times. It’s about 10 at the moment. It goes above 30 as markets get choppy. Today, at around 10, the market’s very flat and complacent.
VIX acts as a fear index even if the market isn’t more volatile in a bear market. In other words, even if the market doesn’t move much, VIX goes up anyway.
That means that Standard & Poor’s 500 index puts are a good deal. As the index drops, the implied volatility will rise, so the index puts will rise more than the index drops.
The Chicago Board Options Exchange enables you to trade VIX options, but only out six months.
There are ETFs tracking the VIX, such as the ProShares Ultra VIX Short-Term Futures ETF (UVXY). That takes a two times leverage on VIX, but it has a huge tracking error. That means unless it goes your way very quickly, you’ll tend to lose money on it.
My conclusion is that you should use VIX as an indicator of what the market’s mood is and as something that helps you with out-of-the-money puts.
But don’t trade it directly; it’s a real Las Vegas sort of game.
This is Martin Hutchinson, signing off.
Senior Analyst, Wall Street Daily