The market’s so-called fear indicator is not always a good predictor of where the market is headed.
But futures on the CBOE Volatility Index (VIX), as the indicator is called, can often say a lot about where the VIX itself is headed, says Randy Frederick, director of trading and derivatives at Charles Schwab.
Last Friday, there was a gap of $1.50 between the VIX and the VIX futures contract that expires on April 19. While that gap might be expected if the contract expired a month from now, with the expiration date so close, the gap should be more like 10 to 20 cents, Frederick says.
“This was giving me a flashing red light,” he said.
Today (Monday), the VIX spiked more than 20 percent not long after the market opened, reaching nearly 19. It settled back to just under 18 at mid-day.
Because of the gap between the futures contract and the VIX on Friday, Frederick expected a sharp fall in the market today. In fact, S&P futures indicated the Dow would drop at least 80 points before Standard & Poor’s announced its negative outlook for long-term U.S. debt.
Even with Monday’s huge spike, a VIX above 18 is back in more normal territory, Frederick says. On Friday, the VIX had closed at 15.44, nearly a four-year low, which reflects a level of complacency about the market that doesn't seem warranted, he said.
"With a couple of less than stellar responses to a few big earnings reports already, monetary tightening in China, a couple of economic reports that have missed the mark a bit and a sprinkle of new debt concerns in Europe, we have a climate for a very uncertain market; not necessarily bearish, just uncertain," Frederick said in a note to clients late last week.
Now that the VIX has reached nearly 18, it's likely to stay there as the market faces a heavy week of earnings releases and a three-day weekend, says J.J. Kinahan, chief derivatives strategist at TD Ameritrade.
“Often in times of uncertainty, people pay up to buy protection into weekends,” Kinahan says.
But some investors are worried beyond this week. Investors on Monday were snapping up VIX “calls” with expiration dates of May 21 or May 25, meaning investors want to be sure their portfolios are protected from a market drop, he adds. Calls are contracts that give investors the right to buy a security, or in this case the VIX, on a specified date.
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