If there’s one point I would emphasize when VIX watching, it’s to pay the most attention when it does something unusual.
Most times the VIX does the “expected.” It lifts when the market tanks. It tanks when the market lifts. It rises ahead of an expected news event, and then declines after the news comes out. It declines on Friday afternoon as traders seek to avoid paying too much for weekend decay on SPX options. And then, it rallies on Monday as the calendar catches up to the options. (Learn more about this VIX quirk.)
But today, it did the unexpected.
On Friday, the VIX behaved as it usually does, i.e., it declined on a Friday into a strong market. In fact, it declined to five-month, post-flash-crash lows. Then, on Monday, the market opened up modestly and traded within a small range for the rest of day.
If you had me take VIX off my screen, and then speculate as to what it did based on the market action, I would have guessed that it was up small early in the day, and then drifted. And I would have said that the only reason for the rise in the morning was the offset of the Friday decline.
Yet, the VIX did nothing of the sort. It opened weak, and got weaker. And, again, this was off five-week lows. This is one of those times when we need to sit up and take notice.
What should we notice? Well, that’s a trickier question.
The VIX is exhibiting clear signs of complacency. We consider the VIX oversold when it closes 10% or more below its 10-day simple moving average (SMA). Well, it closed about 14% below its SMA. That’s bearish for the market, but I wouldn’t go loading up on SPDR S&P 500 (NYSE: SPY) shorts just yet.
“Complacency” does not work as well as an indicator as its evil cousin, “fear.” Fear tends to resolve relatively quickly, while complacency can linger and linger. Likewise, complacency is consistent with the larger uptrend in the market, and thus, in a way just confirms what we already know. A fear spike within a market uptrend provides a better short-term signal than a complacency spike.
And, finally, VIX futures still don’t buy the VIX complacency angle. November futures carry a $6.50 premium to the actual VIX, which is at or near a record level of premium for a future this close to expiration.
So I’d suggest that while the ugly VIX might signal a pause in the rally, it’s highly unlikely it predicts a top.
Follow Adam Warner on Twitter @agwarner.
The ‘Off the Charts’ Options Trading Secret — In this just-released guide to chart analysis, you’ll discover which chart patterns are the most reliable, how to avoid “sucker charts,” the characteristics of a true breakout, how to know when the big-money insiders are making a move, and more! Plus, two current trades to get you started. Get your FREE copy here.