Volatility at New Low

In The Highstreet Group by John Bartoletta

VIX at 52-week low, extreme low levels of volatility in equities raises concern.
The CBOE Volatility (VIX) index is an estimate of future volatility based on the implied volatility of options on the members of the S&P 500 index. It is a sentiment indicator that reflects the level of fear or complacency in the U.S. equity market. High readings of the index show fear and low readings complacency. The recent reading of 10.73, registered on June 6, was the lowest reading since Feb. 26, 2007, which takes us back to pre-financial crisis levels.

The chart above is the VIX index with volatility bands based around a 60-period simple moving average. The chart displays bands to the upside of the simple moving average at 1, 2 and 3 standard deviations. To the downside it shows bands that are minus 1, minus 1.5 and minus 2 standard deviations from the simple moving average.

The difference in the band settings to the upside and downside is to reflect the natural skew found in implied volatility measures as they spike much more sharply to the upside. The VIX is currently minus 2 standard deviations from the 60-day simple moving average for the first time since early 2012, highlighting the extremely low level of expected volatility in equities at present.

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The second chart (shown above) compares the normalized implied volatility of several asset class proxies. Represented are equities (green), fixed income (red), foreign exchange (pink), crude oil (black) and gold (yellow). There is a clear downward trend in implied volatility across all asset classes during the past year with all indexes at or near lows. It’s important to note that the VIX index is not an oscillator. Just because it is at an extreme low does not necessarily mean it must rebound. Even so, given the extreme low levels across markets, once volatility picks up there is a good chance it will move higher quickly.

When the markets correct the volatility will increase rapidly and revert back to the mean. Currently we find ourselves at an inflection point and possible reversal. As the seasonal period runs its course and/or the markets tell us that they want to move higher toward late summer and early fall months, we will remove the hedge and begin the process of getting back into the markets and get fully invested. Until then we remain diligent in our research and will continually monitor the markets as we look for a sell off to find or more fair valued entry point.