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VIX Retreat – Return to the New Normal

Long gone are the days of 10-13% volatility that we experienced during the leveraging mania of 2005 & 2006. I believe the credit crisis that started in earnest during 2007 has left its mark.  Volatility will remain elevated as continuing uncertainty and fear will impact market participants for months and possibly years to come. When the VIX spiked past 30 at the end of October, many were claiming that it was proof that another market meltdown was upon us.  I explained some reasons for a spike in the VIX, but many were only looking for evidence that supported their beliefs:

The VIX shot like a rocket from nearly 20 to over 30 in a few days time

The VIX shot like a rocket from nearly 20 to over 30 in a few days time

Instead of melting down, the market had other ideas in mind and melted up.  We are currently sitting near our highs and the S&P 500 seems determined to break 1100 for the first time since it crashed through a little over a year ago.   The committed bears need to reassess their positions until the market begins to prove them right.  Despite some very ugly fundamentals in the economy, the market continues to march higher without many hiccups. Some of this march upward is due to dollar weakness and much of it is due to massive liquidity injection provided from the fed.  The reasons are immaterial; the fact is that the nominal market is moving higher until it proves otherwise.

SPX - A long and very strong trend

SPX - A long and very strong trend

Despite my negative position on underlying fundamentals and my belief that the government responses are only setting the world economies up for a fall in the future (kick the can down the road), I do believe that for the time being the market has returned to its “new normal“.  Volatility will remain elevated as conflicting economic data is digested, but volatility will not reach the heady days of 4th quarter 2008 because the apocalypse is behind us.

20-30 on the VIX seems to be the "New Normal"

20-30 on the VIX seems to be the "New Normal"

Does this mean that I think that the market cannot correct strongly in the coming months?  Absolutely not.  This only means that I believe that selling volatility when it spikes is back en vogue.  So the next time the VIX spikes to 30 on the S&P 500, think about selling puts and calls rather than buying.  Let the others take the losing side of the trade.  Just remember your stops in case a new crisis rears its ugly head.

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4 Responses

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  1. Randy Woods says

    Option trader conventional wisdom – Sell when you can, not when you have to. Or was that buy? Either way, be a contrarian.

  2. Angela says

    whilst everyone believes we are in a new bull market, expect the opposite and without warning, like Randy says, be a contrarian.
    Personally l think by the end of Jan we will drop hard and continue for months.

    Ang

  3. SurlyTrader says

    You are right, from an option seller’s perspective it is best to sell when everyone else is buying and buy when everyone else is selling. This works until it doesn’t, which would be a massive move in one direction. My advice is always to take those losses early. Set a stop so that 2 winners can make up for your one loser. If you have wide stops, then you have to increase the number of written options that expire worthless for every loser.

  4. SurlyTrader says

    I will not disagree that a strong move downward is possible, but until the market turns south and confirms it, I’m not going to fight it. As we speak the S&P appears to open above 1100 and will probably try to build some strength there.



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