May 10, 2017 | by James Behr Jr
The CBOE Volatility Index or “VIX” is an index that measures the market’s expectation of volatility over the next 30 days. The actual computation of the VIX is complicated but is based on current S&P 500 option prices and the expected future option price movements. Investors that are worried about large moves in the market will be willing to pay more for these options, which in turn will drive the index higher. It is often viewed as a fear gauge for market risk in the future and usually moves inversely to S&P 500 Index. Thus, if the S&P 500 is up the VIX will typically be down and vice versa.
Monday, the VIX closed at 9.77, the 4th lowest level for the VIX on record, and only the 10th time in history it has closed below 10. Tuesday marked the 11th time in history closing at 9.96. Why is the VIX so low? Well there could be several reasons. The first and most obvious is that people are not willing to pay for short-term protection. The French election results confirmed predictions, no news is good news concerning the new administration’s attempts at tax reform, inflation is steady, unemployment is low, and the expectations are that the Federal Reserve will continue on the path they laid out in previous statements. This adds up to there not being a lot to worry about, for now. Moreover, with the market near all-time highs it would make sense for the VIX to be near its lowest levels because of the typical inverse relationship. Exchange traded products based on the VIX could also have an effect although the magnitude is mostly unknown. All of this can change quickly if geopolitical turmoil increases, tax reform falls through, or the Fed begins to raise rates quicker than anticipated.
News sources are running articles with titles “Why is volatility so low and what should we do now? or “This extremely quiet market could be setting a trap for investors.” News articles like these often entice investors to make changes to their portfolio or incite fear. While volatility will increase at some point, this news is much ado about nothing and investors should continue to focus on their long-term goals. We frequently hear about the fear of investing at all-time highs or the desire to wait for a correction. This fear commonly leads to missing out on large gains and regret. Investing with a hedged approach makes it easier for investors to participate in the market gains while providing the comfort of downside protection.