As option trading investors we’ve studied and utilized the CBOE Volatility Index (CBOE: VIX) for years because it measures the implied volatility of the SPDR S&P 500 Index (NYSE: SPY). It also is a measure of trader sentiment and fear/panic/wall of worry sentiment levels. Certainly extremes in the VIX often can be used as pivotal turning points in market timing — but also quite often (especially in recent years) it can be a good leading indication of a volatile, whippy market.
Individual investors can trade the VIX through the iPath S&P 500 VIX Short-Term Futures (NYSE: VXX) and the iPath S&P 500 VIX Mid-Term Futures (NYSE: VXZ) Exchange-traded funds, which track VIX futures prices and their options.
The VIX has basically been in a steady downtrend since a spike in May 2010, but we’ve recently seen an upward burst, likely due to unpredictable political events overseas and a subsequent rise in certain key commodities such as oil. Nonetheless, the recent move in the VIX is interesting from a technical analysis perspective. Take a look at the daily chart below:
So, we can see above that the 18/18.5 level has increasingly become an important “line of demarcation” in recent months. Basically this area is acting as kind of the bench post below which traders are feeling relatively calm and perhaps complacently bullish, while above it fear/panic levels are rising.
The recent gap up in the VIX on Feb. 22 has now formed an interesting “island” technical pattern — we haven’t yet “filled in” the gap on the downside. Until we do (which may not occur for some time), volatility and whippiness in the stock market are likely to persist. Also note that during this same move the VIX moved above both its Top Acceleration and Bollinger Bands — it hasn’t done this in quite some time and this is another indication that volatility may continue to linger in the short-to-medium term.
Bottom line, the recent VIX activity and pattern is causing us to be somewhat more tempered in our stock market outlook as risk appears to be lingering. The VIX breaking back down below 18 (for more than one day) would likely be a healthy sign for another strong market up-leg.
Disclosure: As of this writing I have no positions in any of the stocks mentioned.