The VIX seems to be caught in a range between 22 and 30. Could you discuss the implications of it breaking this range either way? To the upside (i.e. above 30), do you anticipate that to be linked to a “major” sell-off, maybe lower than the September bottom? To the downside (i.e. below 22), would you see an important rally accompanying the break and where would you see the VIX heading for next “support”?
The VIX is a sentiment indicator, and as such, it gives the best readings at extremes. We refer to the ‘normal’ range from 20 to 30, very much what the VIX has been tracking in of late. At the low end it shows complacency, i.e., little volatility in option prices and that indicates little fear that tends to drive the market. At the upper end it shows more anxiety that can fuel the market when new money comes in. In this normal range you can see readings near 30 trigger minor rallies as we saw two Friday’s ago when the VIX spiked to 30 intraday before that move.
After strong selling, it usually takes more than a reading of 30 to make the turn. That would accompany stronger selling that typically drives the VIX higher. To break over 30, it would not need a selloff to the September bottom. The question is whether it needs to get much over 30. The VIX shot up to 57.31 during the week the market reopened, the highest reading since 1998. Other sentiment indicators spiked to highs as well. That was enough to turn the market from its continuing downtrend. I doubt whether the VIX would have to spike that high to turn this test back up from this current downtrend, but it certainly would take a reading well over 30. That can be accomplished without a major breakout to the downside. The volatility indexes are starting to move up sharply this downturn as the Nasdaq hit a new 2002 low and the S&P is heading down to test its low.
As for the downside breakdown of the VIX, it would not take a major upside move to lower volatility below the 2001 range. Indeed, at this low level, there would be little impetus for the market to drive higher outside some major unforeseen news. It is hugging that range most of the time now, somewhat disconnected from the action in the indexes. From this level, it is more likely that it rallies higher on further selling before the next major move higher. At that point we will see volatility head lower as the rally gains steam. Volatility gives signals at the extremes. The low volatility we have seen acts as molasses on any rally. Once it gives a sharp spike higher and the markets start to move, we don’t get too worked up about it until it settles back down to extreme low levels as we have had.
