Today we’re going to do one simple chart that hopefully will give us some guidance on what the crowd is thinking about the market and how we should consider that attitude in our investment strategies.
It’s going to the simple chart. Now, some of you are familiar with what’s known as the VIX, also called the Volatility Index. It’s a measurement of the premiums that investors in both calls and puts, so options, are paying for those options. Now remember, some people that buy options are buying them to lock in a price, but a big, big, big chunk of the options market are speculators and hedgers. So these people are trying to hedge out their positions and sometimes it’s commercial people. Often commercial people use futures, but there are large managers that will use options to hedge their portfolios, specifically if they have exposure on one particular stock. But generally speaking, as a crowd, when we look at the whole pile of different types of options investors, the premiums tell us just how badly they want to buy these options. Because for every option that is written, somebody has to buy them.
Obviously, the more volatility that is anticipated by the person or group or company that is writing the option, if they’re anticipating a higher level of price volatility over the period that occurs before this option expires, they want a bigger premium to protect themselves. So for that reason, the volatility index is something that’s telling us just how much people are willing to pay for that protection or for that option to get into or out of a stock. It’s a good indication of the volatility that is anticipated on the market and it stands to reason that the lower the VIX indicator is, the lower the expectations are for volatility. We all know the truth behind extremes in expectations. When we don’t expect something to happen, that’s when it’s most likely to happen and because we’re less guarded for that event, that event when it occurs results in a more extreme movement on the market.
So let’s take a look at some history here. This is going back just to 2016. I have really long charts on the VIX. Here’s a chart going back to 1990 and you can see the general trend. What I’ve circled here is when markets are too complacent or too fearful. So the premiums on these options are very high here because everybody’s scared out of their minds and worried about what’s going to happen the next 30 days, et cetera. And when premiums are low, it’s because, oh, it’s always going to be the same, right? That’s the way the crowd is thinking. So generally speaking, when you’re down at the lower end of this range, it means that people are pretty complacent. That’s a time to start worrying and this is actually when people are extremely scared.
That’s a great time to be not so scared yourself. So this is a closer view. That original chart is a closer view of the market. We’re only going back to 2016 versus 1990 on the bigger chart that I just showed you. But I want to show you some probably intuitive trends that you’ll see when the S&P 500, which is this bottom line is going up, the VIX goes down. Why? Because people are becoming more and more comfortable with the market as it goes up. Everybody’s happy. Now at extreme lows, you know that we’re entering a period of too much complacency. It doesn’t have to go this low. This was an extreme period here, but from anywhere in the lower pink line region, you can see we’re at a point of complacency.
Recently, what’s interesting is the end of the 2021 move was signified by a move of the VIX into just above the pink line. The pink line is about 12 and a half. The VIX was kind of clustering in the 15 to 17 zone, you could say around here, and that offset a move down by the market and of course a move back up in volatility option premiums by the VIX. So what we’ve had lately is a rising market. Yes, the market fell in 2022, but generally speaking this year, during 2023, the market’s been up back to its old resistance points. But still, it has been going up and that has been coinciding with, as expected, a more complacent environment in the stock exchange. People are feeling more comfortable. They do every time that the markets go up. They become more and more complacent.
So this seems to be the newest range that the VIX likes to hang out at. But we’re back in that sort of 15, I don’t know if you can see it on the chart here, but that says 15.78 was the recent low to 17 and that’s where it stands today. It’s about 17.7 as I do this video on the 23rd of May. So what I’m going to suggest here is that the VIX can remain in that complacency zone for a while before the market gets hammered. But if it stays there for too long, so we’re relatively early in the complacency zone, then if it stays there too long, we could be in for some nastiness on the market. The second thing I want you to know is that nothing lasts forever. You can see after a period of say, rising volatility that eventually ends. After a period of falling volatility that eventually ends and this happens over and over on the VIX because if there’s one thing you can say about human neurosis it never goes away.
So either we’re optimistic as all get out or we’re pessimistic as all get out and there just doesn’t seem to be a period of time when we’re always at that Goldilocks level of reasonably optimistic, yet reasonably cautious. We’re either kind of jumping on the boat a bit at a time until it gets full and the boat sinks or we don’t have anybody on the boat and just a few people jump on it and swim to safety or I should say sail to safety. So we’re rarely in the position where we’re just going to float along and the VIX shows us that. It goes up and down like a yo-yo. So we’re at the low end of the range, and that’s really what I wanted to emphasize here. The market has been going up since the beginning of the year and the VIX has been going down and that won’t last forever. Am I going to predict to you when the VIX is going to stop basing and things going to turn around? No, I can’t predict that, but I can tell you that if the VIX stays in that zone of gaining complacency.
In other words, options writers aren’t demanding as many premiums or as high of a premium, I should say, because everything looks good. Well, everything doesn’t look good forever. Things change and that’s the law of life. I think it was the Buddha who said that impermanence is the biggest law of life. So let’s all listen to the Buddha and know that this situation can’t last forever. And let’s trade with a Zen mind as he might have said.
