The New Base Level in the VIX IndexThe VIX index is the Chicago Board Option Exchange’s CBOE Volatility Index, a popular measure of the stock market’s expected price variance of S&P 500 stocks. The S&P 500 is the most diversified of the leading stock market indices.
Higher base levels in the stock market’s volatility index
A correlation with the bond market
Markets across all asset classes face many issues in 2022
As market participants head for the sidelines, volatility increases
The buy zone for the VIX is the 20-25 level
Market volatility comes in two forms, historical and implied. Historical volatility measures a market’s past price variance, while implied volatility is the consensus perception of the future price variance. The primary determinate of call and put options is implied volatility. Options prices rise when implied volatility increases and falls when the measure declines. Options are price insurance, and market participants tend to flock to the options market during bearish periods. Therefore, implied volatility tends to rise during downside corrections. In 2022, the S&P 500 has been trending lower, and volatility has increased from the levels seen in 2021. Meanwhile, the VIX index has been trending higher since reaching a low of 8.56 in November 2017.
Higher base levels in the stock market’s volatility index
The VIX index has been trending higher over the past five years, with two significant upside spikes.
The chart highlights the spikes to 50.30 in February 2018 and 85.47 in March 2020 when the global pandemic gripped the stock market. Meanwhile, the base level for the VIX was around the 10 level from April 2018 through early 2020. In 2020 and 2021, the base rose to the 15 level, and the bottom for the VIX increased to the 20 level in 2022. In the VIX, upside price spikes tend to signal the kind of capitulation that leads to stock market bottoms. While all the leading stock market indices have been declining in 2022, the price action in the volatility index has yet to signal stocks are anywhere near the bottom.
A correlation with the bond market
Stocks and bonds compete for capital flows. As interest rates rise, money tends to flow from equities to fixed-income securities. Therefore, a falling bond market is bearish for stocks.
The trend of higher lows in the VIX is a bearish sign for stocks and bonds. In 2022, the stock market has traded like a whack-a-mole game. While making lower highs and lower lows, declines have led to rip-your-face-off rallies, confusing market participants. However, the overall bearish trends in stocks and bonds and bullish trend in the VIX index is a sign that the bear continues to dominate the markets.
Markets across all asset classes face many issues in 2022
Higher interest rates are bearish for the stock market and bullish for the volatility index. However, the markets face a lot more than higher interest rates in 2022:
The war in Ukraine creates a unique side of problems for all markets. Rising energy and food prices have pushed inflation to a four-decade high, translating to pressure on stocks and bonds. The Fed’s interest rate policies remain far behind the inflationary curve, keeping real interest rates in negative territory and fueling even more inflation.
The bifurcation between the world’s nuclear powers creates trade issues that distort prices, creating raw material shortages in some regions and gluts in others. The tensions interfere with the flow of goods worldwide.
The mid-term US elections in November will determine the balance of power in the House of Representatives and the Senate. The election will be a barometer of support for the Biden administration. Polls point to losses for the ruling party, but the electorate remains divided, with emotions high on both sides. Voters tend to vote with their pocketbooks, but there is much at stake in November.
US energy policy continues to address climate change by favoring alternative and renewable fuels and inhibiting the production and consumption of fossil fuels. The President recently said the pain of higher gasoline and fuel prices is necessary for consumers to shift to a greener path. Opponents contend that the energy shift will take decades, while supporters argue that hydrocarbons continue to power the world. The election will go a long way to deciding if the US continues its green route or shifts back to a drill-baby-drill and frack-baby-frack road to energy independence.
Russia and Ukraine export one-third of the world’s annual wheat supplies and a significant amount of corn and other agricultural products as they are Europe’s breadbasket. Higher food prices and scarce availabilities over the coming months and years could spark a period of upheaval with hungry people in less developed countries dependent on Russia and Ukraine facing famine.
These issues and the unknown are fueling uncertainty in markets across all asset classes with no solutions on the immediate horizon.
Uncertainty is the stock market’s worst enemy. While the Fed attempts to address inflation with interest rate hikes, supply-side economic issues could mean the central bank is fighting an inflationary blaze with a water gun that will only hasten a recession or worse.
As market participants head for the sidelines, volatility increases
Market participants are nervous in June 2022. The price for all goods and services continues to increase as money’s purchasing power declines. Moreover, after the stock market gains over the past two years, monthly IRA and investment account statements are eroding at an accelerated pace. As of June 16, the tech-heavy NASDAQ had lost nearly one-third of its value from the late 2021 high. The S&P 500 was down more than 22.8%, and the Dow Jones Industrial Average fell around 17.5%. Consumer confidence has plunged, and a general disgust and malaise are settling over markets across all asset classes. Rapidly rising interest rates are making new home purchases prohibitive, even if prices come down.
Meanwhile, we are heading into the peak summer months with the stock market in whack-a-mole mode. The odds favor a retreat to the sidelines for many market participants over the coming weeks and months. Less participation causes volumes to decline, and in the current environment, will likely increase price volatility. As many traders, speculators, and investors turn off their screens and head off on vacation, bids to buy are likely to disappear during selloffs, and offers to sell will evaporate during recoveries, making rip-you-face-off rallies even more dangerous. Higher volatility will only add to frustrations over the summer of 2022.
The buy zone for the VIX is the 20-25 level
The VIX was over the 33 level on June 16, but it fell as low as 23.74 in early June. The trend of higher base levels for the volatility index increases the odds of success for purchasing the VIX futures or VIX-related products on dips to the 20-25 area.
The VIX is a trading, not an investment product. Approach the VIX with a solid risk-reward plan and stick to the program. Look for better than even odds opportunities, take small losses at risk levels, and look to increase profit horizons when the volatility index rises. When adjusting profit targets, remember to raise the risk points to levels that protect profits and capital.
The trend in the VIX is higher, and the potential for a substantial upside price spike is rising. Trading the volatility index from the long side could be the optimal approach over the coming weeks and months as the market faces significant issues and liquidity is declining.
Fasten your seatbelts as the whack-a-mole stock market could experience head-spinning moves over the coming weeks and months.
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