The CBOE Volatility Index bounced 9% on Monday after Wall Street’s fear gauge fell to a five-year low last week with stocks grinding steadily higher this summer.
Volatility-linked products that track VIX futures contracts such as iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX), ProShares Ultra VIX Short Term Futures ETF (NYSEArca: UVXY) and VelocityShares Daily 2X VIX Short Term ETN (NYSEArca: TVIX) traded higher Monday.
Volatility ETFs have been thumped by a falling VIX as well as “contango” in the futures market. [Double Whammy for Volatility ETFs: Falling VIX and Contango]
“Market volatility has fallen sharply in the last few months and on Friday, the VIX index closed at 13.45, its lowest daily close in over five years. This lack of volatility is in part due to a rising stock market – stock markets, like roller-coasters, tend to be noisier on the way down than on the way up,” said David Kelly, JP Morgan Funds chief global strategist.
“It also may reflect a global financial environment where tail risks appear to have diminished,” Kelly added, pointing to receding fears over Europe’s debt crisis, global energy supplies and the U.S. economy. “However, the lack of volatility may also reflect a general lethargy among investors, the idea that, if nothing is going on then they don’t really need to do anything.”
Last week, the VIX fell under 14 to the lowest level since June 2007.
“The VIX has lost nearly half of its value since early June, which has coincided with a more than 10% rally for the S&P 500,” WSJ.com’s MarketBeat reports.
“But be careful if you think the VIX has nowhere to go but higher – in 13 of the last 22 years, the ‘fear index’ has bottomed somewhere between November and January. August saw the low VIX for the year only once, in 2000,” said Nicholas Colas, ConvergEx Group chief market strategist, in a note.
Although the spot VIX is at a multiyear low, VIX futures suggest investors expect market volatility will pick up in the coming months. The VIX futures curve is the steepest since the financial crisis.
“In practice, the [spot] VIX measures expected changes in stock prices over the next 30 days. That’s it. It is heavily informed by recent actual volatility,” Colas wrote.
“A VIX reading of 14 shouldn’t make anyone, anywhere, feel more confident about what will come down the road in October or beyond. It is simply the relative assurance that the weather will be clear tomorrow,” he said. “Volatility, like the weather, changes with the seasons and other factors. And even if you are sleepwalking, it is wise to take an umbrella.”
CBOE Volatility Index
Full disclosure: Tom Lydon’s clients own TVIX.