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There is a key index, known as the VVIX, that’s been telling the tale of the tape.
And between it and the CBOE Volatility Index (VIX), the markets are telling me volatility is here to stay for at least the next 30 days.
How am I able to interpret the information?
Let me break it down for you piece by piece.
First, let’s do a quick refresher on the VIX.
VIX 101Most retail traders and investors are familiar with the VIX (aka the “fear” index), which is based on S&P 500 index options and measures how much volatility the stock market expects to experience.
And we know that the VIX often moves in the opposite direction of the stock market.
So when stocks rise, the VIX sinks, and vice versa, as shown in the daily chart below that compares the S&P 500 (top) to the VIX (bottom).
The VIX is a complex calculation done by the Chicago Board Options Exchange (CBOE).
They take all the options on the S&P 500 and use this calculation to come up with a number known as the VIX.
This number has two meanings:
- The implied move for the S&P 500 over the next 30 days as calculated from the options on the S&P 500.
- The demand for options 30 days out on the S&P 500 index.
More often than not, they do this by purchasing put options that pay out when the market drops. This allows them to offset market risk against a basket of stocks they own and expect to outperform the market.
When stocks drop, demand for both put and call options rises, as markets tend to drop violently and recover quickly.
This hedging action is what causes the inverse relationship between stocks and the VIX.
VVIX 101The VVIX is the implied volatility index of the VIX, which can sound a bit esoteric.
But all it means is that you can buy options, both puts and calls, on the VIX itself.
The VVIX does the same thing the VIX does for the S&P 500, just with the VIX.
Think of it this way: The market is a sprinter. The VIX is the coach who runs beside the runner to time them. The VVIX is the guy who evaluates the coach.
The VIX and VVIX typically move together in opposition to the stock market:
- When stocks go up, both the VIX and the VVIX go down.
- When stocks go down, both the VIX and the VVIX go up.
- The implied move for the VIX over the next 30 days as calculated from the options on the VIX.
- The demand for options 30 days out on the VIX.
Why I Expect Volatility to Stick AroundSince both indexes measure 30 days out, my forecast does as well. In the chart below, you’ll see how the VIX is at relatively high levels while the VVIX is at relatively low levels.
Reading this at face value, the VVIX is saying:
That’s normal when markets are on a bull run and the VIX is at or below historical averages. But neither of those two things are true right now.
Reading the VIX at face value, it’s saying:
Taking those two statements together, we get the following conclusion:
Here’s what that means for you.
Where We Go from HereMarkets will eventually find a bottom.
Most of the time, that coincides with capitulation in stocks, the VIX, and the VVIX.
That’s when everything makes a high-volume reversal, as shown in the chart below.
The yellow arrows highlight two times this occurred, but you can see it on many other occasions as well.
In order for markets to find a bottom, we will likely need to see option demand on the VIX itself spike.
Therefore, I’ll be keeping an eye out for a rise in the VVIX, and I advise you to do the same. Later this week, I’ll cover some other areas of the market where I expect to see major shifts, so be on the lookout.