Source: Golden Ten Data
The VIX Index indicates that the stock market may experience a wave of sharp declines. When VIX is low, history shows that the stock market often faces adjustments.
Investors may soon learn a tough lesson about the Chicago Board Options Exchange Volatility Index (VIX), especially those excited about milestones such as the Dow breaking 40,000 points for the first time.
The information on the VIX Index is that stocks are likely to experience a major new decline.
When the VIX Index is very low — as it is now — major stock indexes tend to reach new highs, and investors become greedy. History shows that there are always things that will break this situation.
Volatility is back to average. It acts like a rubber band. When the volatility reaches such a level, it will inevitably bounce back to the average level. The reason for a return to the mean is always a drop in stock prices, which drives up the volatility of options.
Volatility, which sometimes exceeds the average level, is triggered by stock market fears reacting to geopolitics, hawkish economic data, or too strong investment sentiment.
VIX is a forward-looking index with complex internal mechanisms, making this so-called fear index one of the most misunderstood indicators on Wall Street. Its long-term average is around 19, a level that essentially prices the S&P 500 to fluctuate around 1.2% daily over the next 30 days. Recently, the VIX index was at a sluggish level of around 12.
For option-centered investors, the low level of VIX means there are no fear or greed premiums in option pricing for S&P 500 options and many of their constituent stocks. Lack of bias (the difference in volatility between put and call options) is a big problem for options strategists and institutional traders. A flat bias, or little difference in the volatility between bearish and call options, indicates that investors are too optimistic about stocks.
For institutional investors, a flat skew is a sign of action, especially ahead of an event-intensive market calendar.
Known unknown events that could cause panic and increase VIX include Nvidia (NVDA.O)'s first quarter earnings report on Wednesday, the June 7 non-farm payrolls report, and the June 12 consumer price index report, which took place at the same time as the Federal Reserve meeting.
If these reports cause the stock market to plummet, investors should be prepared to sell cash-guaranteed put options at or below the relevant stock price for a period of one to two weeks. Applying this strategy to blue-chip stocks that can be held for several years, and ideally longer, can monetize market fears and get rewards from long-term stock investors through the options market.
Institutional fund managers can use “low bias” to buy index put options in case VIX soars and stocks fall. This strategy is best left to professionals, as it will drag down performance if the stock continues to rise. Instead, most people should focus on specific stock goals rather than doomsday scenarios.
Most people talk about the stock market at the index level, but the market is usually experienced through individual stock positions. Most people should take advantage of widespread market turmoil to increase their core stock holdings or buy their favorite stocks at lower prices.
Any discussion about volatility must be obscure and difficult to understand. To simplify, remember the VIX trading motto: when VIX is low, it's time to leave; when VIX is high, it's time to buy.
Throughout history, low VIX readings usually indicate weak stocks, while high VIX readings indicate stronger stocks. Incorporating this insight into your investment handbook should help you better manage market fluctuations.
editor/tolk