It’s True: Market Volatility Is (a Bit) Higher

Believe it or not, VIX – the most widely followed measure of market volatility – has actually risen a bit over the past week. The reason this may seem hard to believe is that moves of one or two points on the S&P 500 are now considered an advance, while a 10-point move is viewed as a big deal. Keep in mind a 10-point move amounts to just 0.4 percent. In the past three weeks, on only one day has the market’s change amounted to 0.5 percent.

Any psychologist can tell you that people tend to adapt to whatever the most recent norms are. But at the same time, when norms change, especially if the change is abrupt, it can be upsetting, leading people to overreact.

The major question is what could be the catalyst for a significant change in market action. The short answer is we don’t know. But we do know that our indicator for VIX continues to forecast that such a change is likely, perhaps even within the next month. Our indicator is not a black box – it is constructed on rational principles – so we can say that the persistence of very low volatility combined with the market’s history of dynamism is one variable pointing to a change. Another is that our SPY indicator has turned negative, not so negative that in and of itself it would justify a put option, but negative enough to suggest the market is more likely to be lower than higher in coming months. And given the market’s persistent if grindingly slow upside, a lower market could have an upsetting effect on market psychology that would feed on itself.

Still another sign of the potential for greater volatility is that some of our other indicators have been changing quickly. Our oil stock indicator reversed quickly from solidly bullish to solidly bearish. As a result we opened a put option on oil stocks today. Somewhat disappointing is that our gold indicators, which just a week ago seemed on the verge of turning favorable, did an about-face and now are close to outright sell signals. Our other indicators remain range-bound in neutral territory. The indicator closest to a buy is bonds, which is consistent with the Fed notes released this afternoon that suggested a slight dovish bias.

During the week we did close out one half of our recent trade for a quick profit and as mentioned above are now sitting with just a put option. Put options are the most leveraged way of playing a projected increase in volatility, since increased volatility implies increased downside action, which would combine with increased premiums to boost the option.

But again we underline that the put option should be equivalent to only half a position, while the longer-dated oil trade is a full position. Please stay tuned for further updates, as in the current market sudden changes in the indicators and markets are more likely than under more normal circumstances.


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