Like most people, stocks nudging or at record highs at a time when we are still recovering from a major shock to the economy make me nervous. I know that the stock market looks forward, but it just feels right now as if we have got way ahead of ourselves, with the market ignoring some very real risks and pricing in perfection. That nervousness causes me to look for potential signs of a problem every morning, and this morning’s candidate for a predictor of doom is an elevated VIX.
If you follow markets at all, you have probably heard of the VIX. Most are aware that it is a "fear index" for the stock market, meaning that it moves higher at times of uncertainty. That is true but in reality, most of the time, a jump in the VIX simply tells you what you already know. It measures what the options market tells us about stocks. If traders expect a drop, they demand a higher price for puts, options that benefit when a stock falls, and it is that kind of movement that the VIX tracks.
Logically, though, there is no reason options traders are any smarter or more prescient than those who trade stocks directly, so their views tend to simply reflect those of stock traders. Generally, therefore, the VIX trades higher at the same time as stocks trade lower, not before. It usually offers confirmation, not prediction. Even though that is generally the case, there are times when the magnitude of a move in the VIX hints at something that equities or equity futures are not saying out loud, and that is what we are possibly seeing this morning.
At the time of writing, S&P 500 futures are indicating an opening down around eight points, or about 0.2% lower than Friday’s close. The VIX, meanwhile, is up over 5% from Friday. The VIX is far more volatile that the S&P, but even so, that suggests that the potential for trouble in stocks is a lot higher than futures would have us believe. It is often said that the stock market looks forward, but it doesn’t do so as much as options. They are all about where prices are expected to be on given future dates, so a big move in options prices or spreads suggests that a move in stocks is expected to continue.
So, should investors be worried by what the VIX is saying this morning?
Not yet.
If you look at the three-month chart above, it seems that that the move up in the index, while big in percentage terms, looks like nothing when put in context. It is a bounce off the 52-week low and is nowhere near as big as five or six jumps over that short time, despite which we still got to that year-long low last week. In a market that was traded directly, that would be a normal consolidation during a long-term move that could be taken as a bullish sign, but the VIX isn’t a directly traded market. It simply reflects anticipated moves and doesn’t trade off technical signals.
That tells us that this is more than just a normal, corrective pause in a long-term move. It reflects some genuine concern among options traders about what the next week or two could bring in the stock market. At this point, though, it is nothing to worry about. The big move on the chart, back in January, coincided with a drop of around 5% in stocks, so clearly, acting on the back of this move in the VIX would be foolish. Still, there have been times when an oversized move like this has been the precursor to a significant drop in the market, so it would be a good idea to keep an eye on the VIX this week.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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