Should You Be Worried About The VIX?

By Bryan Rich 

September 15, 2016, 6:00pm EST

Since Friday of last week, there have been a lot of reports on the spike in the VIX.  Today I want to talk about the VIX and the performance of major benchmark markets over the past week.

In a world where stability is king, central bankers have been very sensitive to swings in key financial markets, with the idea that confidence and the perception of stability can quickly become unhinged by market moves. When that happens, it becomes a big, viable threat to the global economic recovery and outlook.  It can certainly send policy intentions off of the rails (as we’ve seen happen time and time again with the Fed).

Should they be worried?

With the above said, some might think the biggest threat to a Fed move in September (or December) isn’t economic data, but this chart.


Sources: Reuters, Forbes Billionaire’s Portfolio

First, what is the VIX?  The VIX is an index that tracks the implied volatility of the S&P 500 index.  What is implied volatility?  It’s not actual volatility as might be measured by the dispersion of data from is mean.

Implied vol has more to do with the level of certainty that market makers have or don’t have about the future.  When big money managers come calling for an option to hedge against potential downside in stocks, a market maker on the floor in Chicago at the CME prices the option with some objective inputs.  And the variable input is implied volatility.  When uncertainty is rising, the implied volatility value includes some premium over actual volatility.  In short, if you’re a market maker and you think there is rising risk for a (as an example) a sharp decline in stocks, you will charge the buyer of that protection more, just as an insurance company would charge a client more for a homeowners policy in an area more included to see hurricanes.

So with that in mind, the implied vol market for the S&P 500 had been very subdued for the past 45 days or so, quickly falling back to complacency levels following the Brexit fears of late June.  But since Friday, when market interest rates on government bonds spiked sharply (in the U.S., German, Japan), the VIX spiked from 12 to 20 (a more than 60% move).

That indicates a couple of things: 1) Stock investors were spooked by the move in rates and immediately looked for some downside protection, and 2) market makers aren’t quite as complacent as they appeared when the VIX was muddling along at low levels.  They are quick to raise the insurance premium, highly spooked by the risk of a sharp decline in stocks.

But it looks like this recent spike might have more to do with market maker community that is psychologically damaged by the abrupt market moves of the past eight years.  Gold is down since Friday – giving the opposite message of what the VIX is giving us about perceived uncertainty (people smell fear, they buy gold).  And the S&P 500 has only lost 1.3% from its peak last Friday.

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