VIX Signals

The VIX is signaling all clear ahead right now, but there are warning signs on the front.

For those new to this arena, the VIX is the implied volatility index of the S&P 500 options. I have been successfully using it for more than 15 years as a model input for trading. The VIX has a number of characteristics that make it a great tool for trading and trading algorithms.

So a low VIX with the term structure upward sloping is good for the stock market (the term structure involves looking at the VIX or VIX futures for each successive expiration). But there are a number of measures that are at extreme lows (any mean-reverting measure isn’t good at extremes). The short term historical volatility of the VIX and VIX futures are at the lowest levels since January or well before.  And the VIX term structure out past December (which has all sorts of weird holiday effects) is very very flat, which is unusual with the market at all time highs.

I think we float into the new year, but then I am really concerned. I think hedging is very prudent, done correctly (i.e. in the most cost effective ways). I will be especially bearish if we see VIX contango (term structure downward sloping) with the SPX just slightly off highs, which I would not be surprised to see in the first couple of weeks of January.

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