What is the VIX Telling Us About Today's Market?Jul 09, 2012
Chad Karnes, CMT
When the media speaks, it pays to ignore. When the VIX speaks, it often pays to listen and right now the VIX is speaking.
"Be fearful when others are greedy and to be greedy only when others are fearful” is a well-known adage attributed to the famed investor, Warren Buffett. What is interesting about his statement is that up until the 1990’s there was no generally accepted way to measure real “fear” in the markets. Luckily we now have a few more standard indicators to help with this conundrum.
Today, the VIX indicator is one of the tools used to gauge fear. By measuring the implied volatility of the S&P 500 index options, the VIX tells us the market’s expected volatility over the next 30 days. When the VIX (Chicago Options: ^VIX) rises, expected volatility of the S&P 500 index (SNP: ^GSPC) rises, and when the VIX falls, expected volatility of the index also falls. Often a rise in the VIX corresponds to a fall in the S&P 500 as volatility is associated with falling markets more than rising markets.
Before the mid 2000’s, the market relied on the VXO (Chicago Options: ^VXO), which measured volatility of the S&P 100 options (Chicago Options: ^OEX) to gauge fear. This indicator is still around, but less popular than the VIX. Today, ETF Profit Strategy uses the VIX and VXO as two of its many tools in its analysis.
Even as the headlines below dominated the media on June 21, 2012, as they seemingly have every day this year, the VIX’s low price at $17.44 was not reflecting such fears of eminent demise:
“Europe Weighs Options for Easing Pain for Weak Nations” – NY Times
“Europe takes first stab at building banking union” – Reuters
“Germany can’t save Europe on its own” – CNN
Given today’s negative news driven market, an expected sky-high VIX would not seem out of the question. However, this simply has not been the case as the VIX now sits closer to its yearly lows than highs.
A Solution for Headline Fatigue
If you are like me, then you are probably tired with the amount of negative headlines that have caused many people to incorrectly assume the stock market is in free-fall. However, even though the U.S. stock market (NYSEArca: DIA) has declined from its April highs, it's still ahead on a year-to-date basis. The VIX is still hovering near yearly lows at $17.72 and giving a great trading setup. Investors following the news might be perplexed by this apparent contradiction, but the ETF Profit Strategy newsletter sees it as an opportunity.
Examining the VIX and its relationship to the market, on June 20 the ETF Profit Strategy Update outlined that “a VIX close above $17.44 will be a sell signal for stocks”. The following day the VIX rallied from a lower opening at $16.77, passing through $17.44, and closing up over 17% at $20.46, as the S&P 500 fell almost 2%. The next two updates reiterated the S&P 500 sell signal capitalizing again with a 2% market drop on June 25.
Last night, the ETF Profit Strategy Update released another analysis of the VIX showing key technical levels and another trade setup. The below chart shows some of that VIX analysis and highlights the key levels we are monitoring.
(to see a larger version of the chart click here.)
If used correctly the VIX is another tool to have in the toolbox. Some ETFs that can be used to take advantage of our VIX trade are the ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY), the ProShares Short VIX Short-Term Futures ETF (NYSEArca: SVXY), and the ProShares Ultra VIX Short-Term Futures ETF (NYSEArca: UVXY). The ETF Profit Strategy Update is continuously analyzing the VIX and other setups to help keep profits larger and reduce trading risk.
The VIX resistance and analysis was not created out of thin air. There is a method to our madness and each month the ETF Profit Strategy Newsletter and a few times a week the ETF Profit Strategy Update uses technical analysis and sentiment measures to identify high probability trading setups for the S&P 500 (NYSEArca: IVV), the VIX, and many other indices and ETFs.