The speed at which fear enters and exits the market never ceases to amaze me. While the spikes in fear often arise with rocket like propensity, the crash back down to earth can be equally stunning. Over the past few trading sessions we’ve witnessed this phenomenon play out yet again. Since reaching an intraday high of 24.65 last Thursday the CBOE Volatility Index (CBOE: VIX) has lost roughly a quarter of its value. Those who took advantage of last week’s mad dash into option land have thus far been handsomely rewarded.
To be clear I speak of those who exploited last week’s elevated implied volatility by becoming insurance salesmen of a sort and entering strategies such as bull put spreads. These volatility sellers couldn’t have asked for a better outcome. The one-two combo of plunging volatility and surging stock prices has been the ultimate resolution to last week’s fear fest.
When the VIX rises to lofty levels the headlines fearfully scream of a continued cascade in equity prices. Sadly they fail to acknowledge the more likely scenario that stocks may be poised for a vicious snap back rally. The elevated volatility slices both ways you see. Some of the largest up days we’ve seen this year have emerged on the back of some type of VIX ramp. Look at the strong rallies following the January 28 Egyptian eruption, the March 16 tsunami slide, or the April 18 U.S. downgrade drop.
When the VIX is high and stocks are on the mat, stay sharp. While such a scenario may foreshadow a full blown market meltdown, it rarely comes to pass. More often than not the fear is unfounded.
At the time of this writing Tyler Craig had no positions on the VIX.
Follow Tyler Craig on Twitter@TylersTrading.