Are You Playing Chicken with the Fear Index?James Cordelaine
Imagine being able to calculate the odds of a good or bad thing happening. What are the odds of losing your job? What are the odds you’ll reap a profit of five million bucks your first year in business with only three employees on your payroll? Or being in an auto accident only three miles from your house? Or what are the odds of your meeting the love of your life by next September?
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While we don’t (yet) have the mechanisms in place to assess our individual daily odds of success or failure, I’m sure it doesn’t surprise you that there are ways of determining the potential volatility of markets by getting a window into the minds of expert investors.
One of these is the VIX – CBOE Volatility Index, which stands for the Chicago Board Options Exchange Volatility Index, commonly known as the VIX. The VIX serves as an indicator of the market’s expectation of volatility over thirty days. It’s fashioned with the implied volatilities of diverse S&P index options.
Options that are bought with the expectation that a particular investment, in these cases, indexes, will go up on or before a particular date are known as calls. Those bought with the expectation that a particular investment will decrease on or before a particular date are known as puts. Basically, options give investors a way to speculate while protecting themselves from the hardest impacts of the market – an alternative IRA and 401(k) holders don’t have.
Since these options are registered with the CBOE, an index of volatility can be calculated by analyzing both investors’ calls and puts for the Dow, the S&P 500, and the Nasdaq 100. This calculation is known as the “investor fear index.” VIX values above thirty are considered highly volatile and worrisome; those below twenty are considered calm.
But before getting too wound up in the numbers themselves, here’s what you need to realize: Though markets themselves are moving along at a ho-hum pace, the VIX keeps rising. There appears to be a major inverse correlation right now between the highly volatile VIX and what can only be characterized as an oddly flat S&P 500.
According to CNBC Trading Nation, “The CBOE Volatility Index looks set to log its seventh straight rise Tuesday [June 20], in what would be only the third time the VIX has managed that long a string of gains in the past 20 years.”
Has the market simply discounted the implications of the abysmal May jobs report that revealed fewer than 25% of the jobs Wall St. expected actually materialized? The same jobs report that knocked the Fed back on its heels and caused it to once again postpone an interest rate hike? Is the market oblivious to the significance of a possible Brexit in the next several days, leaving all the heavy lifting to the VIX?
Or perhaps we’re in for a surprise. The Fear Index exists for a reason—to tell us what the savviest investors on Wall St. are thinking. When the experts and professionals are off in a corner doing all they can to mitigate risk, that’s our cue to start looking for safe havens like physical gold. Take a hint from the shiny metal. Unlike the complacent stock market, it never ignores a clear and alarming signal from the Fear Index.