Wednesday, May 10, 2017

VIX Tricks

I'll hold on to you
Till the mountains crumble flat
I'll hold on to you
Until you figure out just where you're at
--Ric Ocasek

As indicated by the 20 yr chart below, the Volatility Index (VIX) has moved below 10 and is marking historic lows. The VIX measures how much investors are willing to pay for options--particularly put options for hedging or protecting long positions.



When the VIX is high, as it was during the 2008 credit collapse, then investors are willing to pay thru the nose for options. As such, the VIX can be construed as a measure of fear.

When the VIX is low, as it is now, then investors are willing to pay little for option protection. In fact, recent reports suggest that buying option protection is increasingly seen as a waste of money. As such, the VIX can be construed as a measure of complacency.

Although the measure currently suggests a fearless, highly complacent market, experience suggests that the VIX is not a good forecasting tool. Stated differently, a fearless, complacent market can continue in that direction for some time.

What we do know is that, when sentiment turns, it is likely to turn on a dime. Increasingly fearless, complacent sentiment helps explain Minsky's theory that stability breeds instability.

Be ready.

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