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Vix is Unusually Quiet

In last August’s turmoil, the daily movement of S&P 500 of 4% was a norm. However, this year, US stocks have push steadily higher to stand within reach of a four-year high. In addition, the market for products that protect against stock market falls has gone unusually quiet.

On 2012-08-13, the Vix Index - a measure of investor expectations of volatility commonly known as Wall Street’s “fear gauge” – the Vix closed at a five-year low of 13.7, down 60 per cent in 12 months.

The level of the Vix is derived from the cost of buying short-term options on the S&P 500, which pay off if US stocks move dramatically over the next thirty days. When the Vix is low, 30-day options are cheap, suggesting there is little demand for protection.

As shown below, with Vix at its lowest in five years of crisis, it could imply investors are scared no more.

Vix_is_Unusally_Quiet_thumb2

However, when Vix index level is low – typically below 15, it could serve as a warning sign that ‘investor’s complacency with risks’. In the past five years, whenever the Vix fallen to such low levels, it has typically indicated a dismal turn for stock markets soon afterwards.

On the other hand, the low level of VIx index could due to the following reasons:

  1. VIx does not take into account of investor with longer time horizons than 30 days. For instance, endowments and pension funds are not keen in protection for one month.
  2. Investors are selling Vix futures and buying longer-dated futures on Europe’s volatility index, the Vstoxx.
  3. Hedge funds, which are considered the most likely to use S&P 500 options and Vix-linked products to hedge, have pulled money out of equity markets and are sitting on a lot of cash at the moment.
  4. "Volatility has fallen because risk had been priced irrationally high for some time, and rationality is only now being priced into the market,” says Douglas Cote, chief investment strategist at ING Investment Management.

As a matter of fact, the low current level should not engender a false sense of security as the Vix index usually climbs in September.

Reference:

  1. Financial Times, James Mackintosh, 20120815, “Investors remain a little fearful”
  2. Financial Times, Ajay Makan & Robin Wigglesworth, 20120817, “Investors baffled by subdued Vix level”