Is the Current Low VIX a Calming or a Warning Sign?

The VIX is a computed index that reflects the estimated market volatility for the next 30 days. It was established by Chicago Board Options Exchange (CBOE) Volatility Index in 1993, and is used by stock and options traders to gauge the market’s anxiety level. Hence, it serves as an indicator on the probable approach of an investor with respect to the market. It is a mathematical measure of how much the market thinks the S&P 500 Index options will fluctuate and is based upon an analysis of the difference between current put and call option prices. To put it simply, VIX rises when put option buying increases and falls when call buying activity is stronger.

From the time of its inception, VIX posted its lowest closing level on May 8th with a 23-year low. It is causing a debate in the business arena between investors, bankers, economists and strategists, as some see it as a good indication of the market towards current events. But others interpret it the other way around, thinking that the market is being too complacent.

On the other hand, while VIX hit its lowest level since 1993, S&P 500 has climbed above its record closing high in April, although its all-time intraday peak remained elusive. US banking stocks were back in the limelight, as the outlook for the US economy brightened. The US interest rates outlook elicited much interest due to the announcement that 4th Quarter GDP growth had been revised up to an annual pace of 2.1 per cent as compared to 1.9 per cent before. This has been a trend ever since President Trump signed executive orders, as chief market strategist at Wunderlich Securities Art Hogan said “I think the real lift in the market was the second round of executive orders from the White House”. With its positive effect, this has helped push the Russell 2000 and NASDAQ indices to fresh records on Wednesday, and the S&P 500 which is considered as the biggest stock market gauge is up by another 0.3 percent at 2,396.7 points.

As any trader knows, VIX is every investor’s fear gauge because data used is dependent on S&P 500 options. It may or may not mirror the movement of the stock market. But in a way, it is used to forecast market sentiment. Policy uncertainty index takes many forms like Economic Policy Uncertainty, where it already raised potential concerns specific to issues related to newspaper reliability, consistency and accuracy, as the index depends on how they use words like “economy, “uncertainty”, “legislation”, “deficit”, or “Federal Reserve”. Hence, research says that with this, they have increased ways in evaluating the index that includes, but does limit to, an extensive audit study on randomly selected news articles. After which the EPU (Economic Policy Uncertainty) Index has been used commercially, as the index contains useful information for decision makers from bankers to policy holders and corporations.

We also have Monetary Policy Uncertainty index which portrays the degree of uncertainty the public has about Federal Reserve policy actions and their corresponding consequences. In other words, VIX is an index that uses option price from S&P 500 to determine the market’s volatility, while policy uncertainty index uses policies and how government handles its day-to-day job from purchasing what is necessary as compared to what is needed now, and how it turns out at the end of the day.

Russiagate is intertwined with the recent firing of FBI director James Comey by President Trump. This has a startling similarity with what happened more than four decades ago, when then President Richard Nixon fired Watergate Special Prosecutor Archibald Cox. This proved to be a move that obviously accelerated Nixon’s departure from office. According to the administration, Trump fired Comey over his handling of the inquiry into Hillary Clinton’s emails. But as per the Democrat party, Comey was fired because of the FBI investigation on suspected links between Russia and Trump’s campaign personnel.

The Watergate scandal has weighed on the stock market for over a year, negatively affecting stock prices then. This was not the only factor though, as this was the time when everyone was taken aback on the first- ever oil shock of the 1970’s known as Arab Oil Embargo. There was the continuous rise in inflation
and interest rates as well as the volatility on metals and dollar. With this, S&P 500 began to fall early of January 1973 until September of 1974, a month after the resignation of former President Nixon.

With all the abrupt changes happening now, there might be a possibility the same thing will happen if Trump will not be able to turn things up and survive the political turmoil he is in now. This might affect the market, causing it to suffer between 10-20 percent correction which can be viewed as a consequence of how the administration is handling things on their way. With what is happening now and how calm the market is in relation to the current events, it is better to diversify the portfolio and hedge with other investment opportunities.

Hedging comes in many forms, but basically it involves either taking equal and opposite positions in two different markets, such as the commodities and currency markets, or opening co-directional positions in counter-correlated assets. The most common instrument for hedging is again, options, as they have limited loss potential and don’t have to be executed if the hedged trade goes as planned. To read more about currency options trading, visit AvaTrade.com.

Ultimately as a trader, be cautious about what is happening and keep yourself updated because when all’s said and done, it pays to have a diversified investment portfolio.