As the CBOE Volatility Index, the so-called fear index, slides below a one-year low, VIX exchange traded product traders could begin to see volatility tick higher in a complacent market.
The VIX, an options-based measure of expectations for price swings in the S&P 500 index, was hovering around 11.6 Friday, after dipping to as low as 11.46 in early trading, its lowest level since March 2013. The low reading reflects the low volatility or greater complacency in the equities market.
Inverse VIX-related ETFs such as the VelocityShares Daily Inverse VIX Short-Term ETN (NYSEArca: XIV) and ProShares Short VIX Short-Term Futures ETF (NYSEArca: SVXY) strengthened 0.5% and 0.7%, respectively Friday. The two have gained about 15.2% over the past month. [Inverse VIX ETF Bets Pay Off on Waning Market Volatility]
“The market’s been lulled to sleep,” J.J. Kinahan, chief strategist at TD Ameritrade, said in a Wall Street Journal article. “At the end of the day, [stocks]haven’t really gone anywhere for most of this year.”
The VIX typically moves higher when stocks plunge. Investors would turn to S&P 500 options to protect their portfolios against any sudden dips.
While the VIX has been steadily declining on a more sanguine outlook in the S&P 500, volatility has increased in small-cap stocks. The S&P 500 is trading around its all-time high, but the Russell 2000 has dipped 7.6% from its own record high in March.
Jonathan Krinsky, MKM Parners’ chief market technician, pointed out that scenarios where small-caps plunge while large-caps remain unfazed are rare occurrences, writes Chris Dieterich for the Wall Street Journal.
Krinsky discovered only two instances in the past 20 years when the VIX touched a 52-week low while the Russell 2000 crossed below its 200-day moving average, and this Thursday marked the third time the same scenario played out. In prior instances – 2000 and 2004, the VIX jumped over the following three months.
“The bulls will argue that a low VIX shows there is nothing to fear, and therefore the market should continue to drift higher with limited volatility events,” Krinsky said. “The bears will argue this is a sign of complacency, and a reversion is likely. We tend to side with the latter, and at a minimum would be looking at hedging strategies.”
Traders seeking to hedge against volatility can take a look at the iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX), the largest volatility-based exchange traded note that tries to track the VIX index. VXX is down 17.2% year-to-date.
For more information on the CBOE volatility index, visit our VIX category.
Max Chen contributed to this article.