What is the stock market’s current psychology and what is the one indicator that best capsulizes it?
Perhaps no yardstick best measures the stock market’s mood than the CBOE Volatility Index or (VIX). Also known as the “fear index,” the VIX represents the expected volatility (up or down) in S&P 500 (SPY) over the upcoming 30 days. When fear is up, the VIX is up and when the VIX is down, the market is less fearful.
It’s impossible to invest directly in the VIX index, which leaves traders with a few choices: VIX exchange-traded products (ETPs) along with VIX derivatives like call/put options and futures contracts.
Although VIX ETPs (VXX) are frequently criticized for their “tracking error” or inability to closely track the real-time VIX, no product will perfectly mimic the VIX.
In the context of a diversified portfolio, VIX is a non-core asset class that is traded not bought and held as a long-term investment.
Thus far in 2016, the stock market’s psychology per the VIX can be summed as “skittish.” This year the VIX has stubbornly remained above 20, signaling a sustainable trend in higher volatility or fear.
Ahead of the +37% spike in VIX (see chart above) that began in December, we wrote to ETFguide PREMIUM members on 12/30/15:
“Our last VIXY trade ended on 12/11/15 with a +14% gain but we never rest our laurels on the past. Stock market volatility has been high for this time of year and the S&P 500 CBOE VIX is already +7% during the past month while the S&P 500 has a modest loss of -0.82%. We’re adding a new position in the ProShares VIX ST Futures ETF (VIXY) at current prices near $13.05 with a buy limit up to $13.25. Right now, VIXY trades near its 50-day moving average and offers a good entry point.”
After three-weeks of holding onto ProShares VIX ST Futures (VIXY), we exited the trade on Jan. 22, 2016 with a timestamped +30% gain. Meanwhile, the Dow Jones Industrials, Nasdaq Composite, and S&P 500 fell 8% to 10% over the same time frame.
All of this proves that profiting from the stock market’s psychology – however delusional it may be – isn’t just a theoretical exercise, but something that can be done by opportunistic traders.
In the end, some of the best VIX trade setups occur when the stock market is in one of three states of mind: 1) complacency, 2) overly-bullish, or 3) overly-bearish.
If you missed January’s VIX surge, don’t miss the next big move. The key to success is to be ready before it happens.