If you watch or read business news, you know that the big story is about low volatility (as measured by the VIX) is. You have also heard or read that a low number (which is kinda rare) is not healthy for markets.
From a technical point of view, this is not accurate. In fact, a low VIX means stocks can continue to rise. A VIX in an uptrend, however, means markets are in trouble.
With this in mind, let’s look at the long-term trend. The continued pattern of lower highs and lower lows portray a bearish trend for volatility. Even the brief spikes on the monthly chart below (which signaled panic) were great opportunities to get on board. The VIX is a major sentiment reading for markets. Big institutional investors rely on it (and other tools) to help determine the timing of placing money in markets.
So, is it safe to get back in the water with the VIX around 10%? Yes, and here’s why. As I mentioned above, the perception in the business media is that we’re in a potentially dangerous condition. Remember just a couple of weeks ago when VIX was hovering around this same level? The markets were hammered and the VIX rose 43% that day – the seventh biggest move in history.
Much of that loss was recovered within a few days. Just a week later the SPX was rising past the old highs. That one-day long spike was a huge opportunity to get in on some trades. Like countless other opportunities, if you blinked, you missed it.
History shows low volatility is not sustainable. Eventually buyers are exhausted and only sellers are left. Option prices are cheap, so buy protection (by buying puts or selling calls). It’s inexpensive insurance for your portfolio. As price ranges widen, markets will move sharply in both directions and volatility will rise. Consequently, prices can also drop – sharply.
While the obsession over a low VIX have many concerned, I am not that worried yet. The VIX Futures plots future volatility months out. An upward sloping curve, which we have now, is bullish.
Bottom line: Low volatility may be worrisome, but it is by no means a reason to shift gears if the market (price action) does not reflect the sentiment. Stay with the trend, be flexible, and be ready to move when conditions change.
