Be afraid? More volatility is coming

Published Fri, Mar 27 20159:17 AM EDTUpdated Fri, Mar 27 201510:45 AM EDT

Evelyn Cheng @in/evelyn-cheng-53b23624 @chengevelyn

The fear is back in the equity markets. Violent gyrations in currency and oil markets are finally spilling over into stocks as investors wrestle with uncertainty over the Federal Reserve 's initial rate hike and a possible earnings decline for the second quarter. The CBOE Volatility Index (VIX) tracks market expectations of 30-day volatility in the S & P 500 and is considered the best gauge of fear in the market. It hit a low for the year last Friday, but this week, shot up almost 47 percent to its intraday high Thursday. "The lower it gets the more sensitive it is to any negative news," said Randy Frederick, managing director of trading and derivatives at Charles Schwab. The VIX spiked 12 percent on Wednesday alone as U.S. stocks declined sharply. The selloff marked the third day of declines—a rare pattern for a market that saw alternating days of gains and losses for much of February and March. "We are closer to raising rates than any other major country," said Dan Deming, advisor at Equity Armor Investments. "That definitely transformed to some serious volatility in some part of the markets and that always has the chance of bleeding into equities." Read More Power Play: Is volatility here to stay? We're possibly headed for a "more significant volatility event because the market has already tried to price out that volatility," Deming said. "Each move lower is less accounted for in the VIX." Another signal that volatility will increase and that a further correction in equities is likely comes from the narrowing spread between the VIX April and June futures bid. The spread was less than 2 points on Wednesday, down a few basis points from Tuesday. Some traders are picking up on the volatility signs. JJ Kinahan, chief strategist at TD Ameritrade, said there was a "pretty big trade" on Tuesday in options that will pay off if the VIX trades sideways through April, but then explode into June—right around the time the Fed may raise rates. The trade was a purchase of an April put option on the VIX with a strike price of 14 and then at the same time, a call purchase that will pay off only if the VIX trades above 20 in June. The index closed Thursday at about 16. Investors buy puts if they think an underlying security will fall, and buy calls when they think it will rise. That's "something to start keeping your eye on, how investors are setting themselves up," he said. "On the other side, nobody that has bet on raising rates has made money in the last two years." Fundamentally, analysts see other reasons for volatility to climb even higher soon. Timothy Courtney, chief investment officer at Exencial Wealth Advisors, said fairly valued markets and impending interest rate hikes lead to increased volatility. "When we start to have bad news, there's little margin for safety (and the market) reacts more forcefully to the downside," he said. He pointed out that the S & P 500 was up about 15 percent in 2012, 30 percent in 2013, and 13 percent in 2014. Those recent gains mean that the market was relatively undervalued three years ago, leaving more room for upside. "The bad news is taken much more seriously because there's much less margin in the price," Courtney said. To be sure, volatility won't last forever. Historical analysis by RBC Capital Markets showed that as the Federal Funds Target Rate increases, the VIX tends to trend lower. Read More How rising rates could shake up Silicon Valley But the market must first pass the hurdles of first-quarter earnings and the Fed announcement itself.

A trader works on the floor of the New York Stock Exchange.

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The fear is back in the equity markets.

Violent gyrations in currency and oil markets are finally spilling over into stocks as investors wrestle with uncertainty over the Federal Reserve's initial rate hike and a possible earnings decline for the second quarter.

The CBOE Volatility Index (VIX) tracks market expectations of 30-day volatility in the S&P 500 and is considered the best gauge of fear in the market. It hit a low for the year last Friday, but this week, shot up almost 47 percent to its intraday high Thursday.