Does the Low VIX Mean the Markets Go Lower? Not Always

Gabe Velazquez

The dog days of summer are upon us.  This means hotter than usual temperatures and vacation time for many folks. For those of us that have kids, this also means that all of that free time with them is winding down, as they’ll soon be returning back to school.

The financial markets —as of late —have also been on a bit of a hiatus. Volume over the last week has been the lowest of the year, and volatility has shrunk to multi-year lows. This unusually quiet environment has prompted many market participants to comment on how low the Chicago Board Options Exchange Volatility index (otherwise known as the VIX index) has been in the last week.  Specifically, that it has broken 15, and has stayed below this number for a few days.  The number fifteen in the VIX has been somewhat of a benchmark in recent years, since it has been associated with market corrections.  Since this is the case, many believe that stocks are due for a pullback.

As is the case with any indicator, we must be careful not to use it as a primary decision tool, but rather as an ancillary indicator that may increase our odds of success. In other words  if the stock index futures are at a supply zone,  and the VIX index happens to be low, then the probabilities are high that the market will fall.

A malady that plagues many traders is that they tend to form an opinion before they gather factual information to support that opinion.  I’m hearing much of this regarding the VIX index. These highly opinionated traders continue to want to short the market simply because the VIX index is below 15.  However, if we look at the VIX index in historical context, we find there have been protracted spans of time where the VIX was under 15 and the market rallied significantly.  We can see this in the chart below:

I know some of you are thinking that this time it’s different and you may be right, however, just be mindful of the past.  By showing you this graph I’m am not by any means forecasting a higher market or consider myself super bullish. I’m simply showing that the facts tell us that the market can go higher even when the VIX is low. The probabilities that prices will go higher are a function of meeting an imbalance of supply; regardless of where the VIX index happens to be.

Incidentally, for those of you who may be interested, the CBOE has a full-size, mini futures contract that uses the VIX index as the underlying asset. For contract specifications and trading times, go to http://cfe.cboe.com/.

As the name states , the VIX  is an index that tries to measure the rate of change for the S&P 500 index going out 30 days,  therefore a lower VIX  reading implies less movement for the underlying index.  For stock index futures traders a lower historical VIX reading insinuates that adapting to this lower range environment is a necessity if one is to survive.  This means lowering expectations for intraday traders and anticipating a change in volatility for swing traders.

Of course there are other non-correlated markets traders can engage in.  For instance, the grain markets (because of drought conditions) have been moving nicely in the last month. Some of the energies, metals, and softs have not exactly been quiet as well.  If you have not traded these markets make sure you understand the margins, contract specifications, and trade times before you get involved.

So as the summer draws to a close, remember that the S&P is not the only game in town; expand your horizons and stretch your scope of potential opportunity.  Because finding low risk, high probability, and high profit ideas come in all different shapes and sizes, regardless of where the VIX stands.

Until next time, I hope everyone has a great week.

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.