Last week I wrote about how low volatility signals complacency in markets – and possible trouble ahead. The Volatility Index, or VIX, can stay low for quite some time while buyers continue to plow money into stocks. Eventually, the fun ends and some traders pay a price for their over-confidence. Today, we’re talking about how to manage low volatility so you don’t end up with a decimated portfolio.
The VIX is a perfect indicator of sentiment even though it may not seem accurate at times. In fact, I often hear things like, “The indicator is broken” or “This gauge’s time has passed.” Like all indicators, it’s simply a measurement tool. Trust that the VIX shows you exactly what you need to know: Which SPX 500 put and call options are attracting money and are most active.
What the VIX tells us about sentiment
When more puts than calls are being bought, the VIX is rising. This is a sign that traders are feeling a bit nervous and reaching for protection in the form of index put options. When you see call volume increase, it means traders are feeling confident and expect markets to rise. The VIX drops in response.
Have you ever heard the saying, “When the VIX is high, it’s time to buy and when the VIX is low, it’s time to go”? It’s an excellent contrary indicator. Right now, the VIX is very low. There are a lot of confident bulls present, and it is very likely that sellers will take prices down.
How to manage low volatility
So this is how to manage complacency in the market: Buy index puts. If you’re a regular reader of this blog, you know I often advise traders to protect their portfolio with index puts. It will ease the sting of a pullback while keeping you in the game. Pullbacks show up eventually, and many traders are not prepared (as is the case now – hence the low volatility readings).