The VIX is trading well below the record highs observed last spring, but it has remained stubbornly high, despite the strong H2 rally in the stock market.
Since hitting its all-time high in the spring of 2020, the CBOE Volatility Index (VIX) has steadily dwindled back down toward its historical average of about 19.
Interestingly, however, the VIX has yet to drop below 19, despite the fact that major U.S. stock market indexes are trading near all-time highs. The VIX is currently trading just over 23.
Traditionally, the VIX shares a strong inverse correlation with stock indexes such as the S&P 500. But since dropping into the low 20s last August, the VIX has traded mostly sideways, even though stock prices continue to rise.
With the coronavirus pandemic still raging globally, and economic uncertainty persisting, above-average levels in the VIX are likely an indication that risks in the marketplace remain high. That’s not to suggest the VIX is guaranteed to explode at some point in the near future—far from it.
But the sustained bid in VIX does indicate that a large portion of the market believes movement in the markets will remain volatile for the foreseeable future.
Another potential risk-factor may relate to the current occupant of the White House. Love him or hate him, President Donald Trump is anything but predictable. Throughout his presidency, Donald Trump often “shot from the hip,” throwing out policy ideas frequently just to gauge their reception.
With President-elect Joe Biden set to be inaugurated on Jan. 20, it will be interesting to monitor whether a change at the top leads to a repricing of risk.
If the VIX drops below 19 in the aftermath of the inauguration, it may become evident that a risk-premium had been assigned to the final months of the Trump administration, or at least to a potentially rocky transition of power leading up to the inauguration.
On the other hand, if the VIX remains above 20 (or climbs higher) after the inauguration, that may be an indication that other concerns are keeping investors and traders awake at night.
As outlined recently by Luckbox, one of those concerns is undoubtedly inflation, which started to tick higher in recent weeks. Inflation is worrisome to the market because it can be a precursor to rising interest rates. Rising rates, amid a tepid economic rebound, are largely viewed as a negative for equity valuations.
Regardless, investors and traders would be wise to monitor the VIX closely in the coming days, as near-term movement in the “fear gauge” should provide important insight into how risk will be priced going forward.
If the VIX drops below 19 in the next week or two, it will be abundantly clear—deservedly or not—that the sustained bid in VIX was tied to the transition of power in Washington.
For more information about the potential benefits of trading short volatility after a pop in VIX, this recent installment of Market Measures is highly recommended. To learn more about trading volatility using options, readers can also review this previous Luckbox post.
Sage Anderson is a pseudonym. The contributor has an extensive background in trading equity derivatives and managing volatility-based portfolios as a former prop trading firm employee. The contributor is not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about any of the topics covered in this blog post, or any other trading-related subject, to email@example.com.