One thing my fellow traders and I have noticed over the past few months is that the VIX (volatility indicator) doesn’t react when the market goes up and down sharply. The VIX is a very important indicator because volatility usually precedes price. Instead, it barely moved as the market surged or drilled. So what’s going on between price and volatility right now?
Some traders believe the VIX is dead. Of course, that’s not far from the truth, but who can blame them?
Volatility seems to have its own way of thinking
When stocks fall, fear rises and the VIX typically rises. But last week saw a major reversal after the Federal Reserve announced another 75bps rate hike. On November 2nd, the SPX 500 rose his 40 points and then dropped 135 points. The net change in the VIX was a whopping 5 cents higher. Traders showed no fear.
A rise in the VIX means that we can expect the index to move within a large range. VIX is 25, rule of 16 This means that the price movement will be around 1.6% every day. If the price doesn’t move much, the VIX will fall, which could lead to an increase in stock prices. But last Wednesday’s move saw him well over 1.6%. In fact it was 3.5%. Still, the VIX barely moved.
So what’s going on between price and volatility?
The VIX gives a lot of information about what’s going on right now, and it looks like two things are happening.
First, there is no demand for VIX or SPX option volatility as traders who wanted index puts as portfolio protection already have them.
Second, the economy appears to be headed for a slowdown due to rising interest rates, quantitative tightening and continued inflation. Traders already know this. The VIX rises when markets and economies experience shocks and require portfolio adjustments.
Therefore, market volatility is not currently leading the stock price.
Compare today to 2020, when the impact of the Covid-19 pandemic was first analyzed. An apocalyptic scenario was rapidly priced in as capital fled the market and stock prices crashed. After calm heads prevailed and a large amount of liquidity poured into the market, the volatility subsided and the market rallied.
From today’s VIX action and stock price action, and from what we know, the stock market isn’t set to crash anytime soon (unless a black swan event happens). But that doesn’t mean stocks won’t go down. When the price falls, it becomes much harder to move up as the lower ranges become the norm.