If you are looking for early warning signs that markets are set for more unsettled times, then the Chicago Board of Trade’s Vix index is a good bet. It tends to spike when traders get nervous.
Without getting into all the gory technical details, the Vix is based on S&P 500 options contracts. Traders can buy options to protect their portfolios from the market falling (or rising, depending on which side of a trade they are on). So the higher the price of these contracts, the higher the Vix index goes, and the more worried about volatility (risk) traders are.
What’s it saying now? In the past two months we have experienced two of the largest percentage moves in the Vix in the index’s history, notes Riskreversal.com. Those sorts of moves would normally suggest “outright panic”. Yet they have taken place at a time when the world’s major stock markets are at or near all-time highs. So what’s going on?
Well, normally the volatility of the S&P 500 index and that of the Vix move largely hand in hand – as one rises, so does the other. But over the course of 2013, the two have parted company as the volatility of the Vix has spiked. It suggests that traders are getting nervous enough about where the market is to insure themselves against any big falls.
These haven’t materialised yet. But the gap between S&P 500 index volatility and Vix index volatility is as wide as it was in early 2007 – just before the stock market nosedived into bear territory. History may not repeat, but it does rhyme, as the saying goes. So if you’ve missed out on the latest stock market run-up, now’s probably not the time to catch a ride.