|The CBOE Volatility Index (VIX) measures implied volatility for eight calls and puts on the S&P 100 index (OEX). When traders are pouring more money into put options than call options, the volatility index moves higher, and vice-versa. Because of this, the VIX tends to move opposite of the market - or more specifically, the S&P 100, which it is linked to. This means that volatility tends to spike at market bottoms and hit extremely low levels during market tops.|
|Graphic provided by: Stockcharts.com.|
|If you look at long-term (14-year) charts for the VIX and OEX, this will become much clearer. For example, notice how the 1998, 2000 and 2002 tops in the OEX all corresponded with extremely low VIX levels. The OEX saw a significant top whenever the VIX pulled back to the $16.00 to $18.00 range. And during the 1998, 2001 and 2002 bottoms in the OEX, the VIX spiked above the $40.00 level. Over the last several years, a VIX level above 35 has been bullish for the market, while a VIX level below 20 has been bearish.|
This brings us to today. Year-to-date, the OEX has been moving lower - albeit gradually - along with the VIX. Since these two indexes normally move in opposite directions, the recent trading activity is bearish. In other words, investors continue to be complacent and optimism remains high despite the recent decline in the OEX. Only when extreme fear enters the market and the VIX spikes to excessive levels do we tend to see a bottom in the market. Since the VIX is hovering at multi-year lows, the OEX may need to see a significant correction (and a corresponding spike in volatility) before bottoming out.
|Glen Allen, VA|
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