The VIX Isn’t Low, the SPX is High

Volatility index is acting rationally in a slow grinding market

   

We noted last week that we see the CBOE Volatility Index (CBOE: VIX) so low mainly because we have very low realized volatility in the market right now. A commentator on FT Alphaville makes this observation.

“In a trending bull market that is at the highest level in years it means that implied volatility (IV) is going to be low, hence VIX being low. VIX is the result of spot levels being where they are, not the other way around. If you are wondering how come with all these problems and scares around us the VIX is at multi-year low, you are asking the wrong question. The right one is why is the S&P 500 Index (CBOE: SPX) at that high level.”

And that’s exactly right.

The VIX has achieved such prominence in the last decade or so among options trading investors, and the cottage industry that analyzes and parses every tick has grown exponentially (cough … including yours truly … cough). But it often becomes a tail-wagging-the-dog sort of take. The VIX does not cause the market to go up and down, it reacts to the market going up or down. Yes, a lynx-eyed observer can sometimes catch VIX turning before the market itself does. But to me that’s almost the whole point of watching the VIX (or any volatility indicator). You want to look for behavior that’s inconsistent with what you can plainly see in the market.

In other words, if the market sits in the midst of a slow, grinding rally, we fully expect the VIX to drift. So observing that the VIX looks low really does not tell us anything. We should see a low VIX. If however we saw this same rally, but with an elevated VIX, we should look further and try to figure out why. Is the VIX foretelling that the rally is on life support? Is it a sign of excess and unwarranted Fear that will ultimately prove bullish? Is it simply an option bid ahead of news pending? Those are the questions we would try to answer.

Right here, right now, I can’t say I read too much into the VIX action. It’s consistent with the market. Yes, I feel that Fear dissipated too quickly from the mid-March spike, almost historically so. But we can also look at it differently and say Fear spiked too fast to begin with, after all VIX lifted 50% in three days on only a 3% drop in the market.

Follow Adam Warner on Twitter @agwarner.


Article printed from InvestorPlace Media, http://investorplace.com/2011/04/the-vix-isn%e2%80%99t-low-the-spx-is-high/.

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