Market Beat: The Fear Index
The stock market regularly goes through cycles of volatility. On average it spends about 85 percent of the time trending upwards with relatively low volatility. The other 15 percent of the time the volatility increases rapidly and the market trends lower.
The historical volatility of the market is measured by using standard deviation. The implied volatility of the market is measured by using an index known as the “fear index” or the VIX. VIX stands for volatility index and is calculated by the implied volatility of nearby options on the S&P 500 index. Options can get very expensive when investors are nervous because many institutional investors will buy put options for portfolio protection when they get worried about the market.
In the last 12 months, the VIX has been as low as 8.50 on Nov. 24, 2017 and hit a 12-month high of 50.30 on Feb. 6, 2018.
The S&P 500 hit a record intraday high of 2,940.91 on Sept. 21 and at that time the VIX hit 11.10. On Oct. 10, the S&P 500 fell 88.22 points from open to close and the VIX jumped to 22.96, more than double from it’s reading on Sept. 21.
The VIX can be a good tool for measuring market sentiment as it will be low when investors are complacent and can rise rapidly when investors get spooked.
Currently, stock investors seem to be nervous about rising interest rates, the possibility of a trade war with China worsening, the price of crude oil rising due to the situation in Saudi Arabia and the upcoming mid-term elections in November. We are also just now getting into earnings reporting season and the bar is set high in terms of earnings expectations. The market is also valued highly here in terms of PE or price to earnings ratio, but that number has dropped somewhat in the last week. The forward PE ratio is 15.7 which is below the five-year average of 16.3 but still above the 10-year average of 14.5.
The VIX moves in the opposite direction of the stock market most of the time and VIX derivatives can be good hedging tools for stock portfolios, though they are not suitable for all investors.
The stock market can be a volatile place at times and investors should understand how volatile their portfolio is and be prepared for the inevitable cycles of market volatility.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.