One thing my fellow traders and I have noticed over the past few months is a lack of response from the VIX (volatility indicator) when markets move sharply higher or lower. Normally, volatility leads price, which is why the VIX is such an important indicator. Instead, it has barely moved when the markets soar or get drilled. So what is going on between price and volatility right now?
Some traders believe the VIX isn’t working. Of course, that could not be further from the truth, but can you blame them?
Volatility seems to have a mind of its own
When stock prices fall, fear rises and the VIX usually picks up. But last week, we saw a massive reversal following the Fed’s announcement of another 75 bps interest rate hike. On Nov 2, the SPX 500 rose 40 points and then fell 135 points. The net move in the VIX was a whopping 5 cents higher. Traders showed no fear at all.
An elevated VIX means we can expect the indices to move within big ranges. With the VIX at 25, the rule of 16 means prices moves will be around 1.6% on a daily basis. If price fails to move that much, the VIX could decline, leading to higher stock prices. But that move last Wednesday was far more than 1.6%; in fact, it was 3.5%. Yet the VIX barely budged.
So what’s going on between price and volatility?
The VIX tells us a great deal of information about what is happening in the moment, and it seems two things are happening.
First, traders who wanted index puts as portfolio protection already hold it, so there is no demand for volatility in the VIX or SPX options.
Second, the economy seems to be heading toward a slowdown with higher rates, quantitative tightening and continued inflation. Traders already know this. The VIX rises when the markets and/or the economy are hit with a shock and adjustments need to be made to portfolios.
Hence, volatility in the markets are not leading stock prices right now.
Compare today to 2020 when the consequences of the Covid-19 pandemic were first being analyzed. A dooms day scenario was being quickly priced in as capital fled the markets and stock prices crashed. After calmer heads prevailed and a slew of liquidity came into the market, volatility was removed and the markets rebounded.
With today’s VIX movement vs stock price action and what we know, the stock market is not set up to crash in the near term (unless a black swan event arrives). However, that doesn’t mean stocks won’t go lower. When prices do fall, rising up will be that much more difficult as lower ranges will be the norm.
