The Chicago Board Options Exchange Volatility Index (symbol: VIX) is often referred to as “The Fear Index” because the index value is derived from demand of S&P 500 (symbol: SPX) puts. The demand for puts, which investors buy to hedge stock market risk, rises in periods of economic uncertainty increasing the VIX Index value. The VIX and S&P 500 typically have an inverse relationship, as the S&P 500 rises the VIX usually falls. The Covid-19 pandemic has brought a high level of uncertainty, spiking the VIX above $85 in March 2020, the highest level recorded since October 2008. The VIX is also a mean reverting index, meaning spikes resolve lower as some of the uncertainties wain and investors become more accepting of risk. Currently the VIX is trading around $25 as the S&P 500 has rebounded due to stimulus from global central banks and governments, optimism surrounding global economies reopening, and vaccine hopes.

$VIX Volatility Index – New Methodology INDX (July 2007 – July 31st 2020)

Source: Stockcharts.com

G&S Perspective:

What does a VIX $25 reading tell us about the current market conditions?

First, since the VIX is a reflection of investor sentiment, we can see that the anxiety of the February-March 2020 decline has retreated and overall investors are positive on the market. However, the VIX spent the majority of the past 2 years in a range of $11-$15, so with a reading of $25 we can presume investors still anticipate much more future volatility than they did over the past 24 months.

Second, with the recent market decline fresh in our minds, investors could rush to hedge (buy puts) with any signs of market weakness. Given the explosive nature of the VIX, it would not be a surprise to see the VIX run above $40 even on a minor market pullback.

Finally, the VIX could remain elevated because of Covid-19 economic impacts and the upcoming U.S. elections. A $20-$25 range could be the intermediate floor until the election results are known.

“If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards”

― Peter Lynch,
American Investor

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