Chart of the Day – This is What Fear Looks Like

by Enis June 14, 2012 12:19 pm • Commentary

The VIX has demonstrated interesting, if not surprising, behavior over the past week.  It is hovering around 24 even though the market as a whole is flat on the week.  The VIX is actually up more than 3% on the year, even with the S&P 500 up almost 5% on the year.  To illustrate the demand for stock options (and hence a higher VIX), here is a chart of the VIX vs. SPX since the start of the year:

I’ve circled in red the times in the past year that the SPX index has touched 1325.  Early in the year, as the market was rallying, the VIX was around 18 when the market touched 1325, which makes sense as the rally was a gradual, low-volatility move higher.  More recently, the VIX has been around 22 when the market first touched 22 on the move lower in mid-May, and then when it retested 1325 at the end of May.

In the last week though, the market has remained around 1325, and while the VIX was slightly below 22 to end last week, you can see in the chart that the VIX has moved almost 10% higher over the course of the week while the market has moved back and forth around 1325.  This is an obvious indication that investors are positioning themselves ahead of the Greek elections on Sunday, with option buyers dominating the market even with markets relatively flat.

With implied volatility moving higher like it has over the past week, we have been reluctant to initiate any new long premium ideas because the options have gotten more expensive.  Why not initiate some option selling ideas?  In general, our strategy is to define our risk/reward, so we’re not too keen on being short options ahead of a very uncertain event.  In fact, I’m not sure most market participants know what to do no matter the result from the Greek elections, because regardless of which party wins, more EU negotiations to amend the current bailout are almost inevitable given the ongoing bank run.

One way I’ve thought about taking advantage of the elevated VIX is buying VIX put spreads to hedge myself in case the markets do rally next week (and presumably, the VIX falls).  But it’s a messy hedge with the Fed FOMC on Wednesday (which might keep the VIX elevated regardless), so I’m holding off for now.