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VIX Flashing All-Clear — or Warning Sign?

The CBOE Volatility Index (VIX) closed below 18 for the first time since July 22, 2011. Sounds like the markets aren't too worried about anything, right?

Hmm.

The VIX (which measures implied volatility, how much the market might move over the next 30 days) is at 17.98.

The historic volatility (how much the market has actually moved over the last 21 trading days) is at 8.5, according to VolX.

That is unusual, says Mark Sebastian at Option Pit, a consulting firm that helps hedge funds construct options trades.

Sebastian notes that normally, the VIX should trade only two to four points above historic volatility. It's trading almost 10 points above.

So something is wrong. There's a disconnect between insurance premiums (the VIX) and the market (historic volatility).

If you need an analogy to figure this out: right now, the market (historic volatility) is acting like it's a 45-year old mother with a perfect driving record, and insurance (the VIX) is pricing like it's a 16 year old that just got his license. There’s a disconnect.

Who’s right? My bet is that the VIX is right: whether it's pricing in Greece, or Iran, or lousy economic numbers, it seems to be saying there will be an increase in the speed at which the market will be moving — at any rate faster than we have been seeing.

That shouldn’t be too surprising. I mean, the rally has been nice, but there has been zero speed to it. Approaching new highs in a very sleepy tape? Suspect.

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