MW The real reason why Wall Street's 'fear gauge' seems so low right now
By Joseph Adinolfi
Forget the conspiracy theories about the Vix being 'broken'. The real reason why the index is so low is because that's exactly where stocks put it
Last month's stock-market selloff ended seemingly as quickly as it arrived. And as one might expect, a short-lived pop in Wall Street's "fear gauge" quickly faded as well.
The swift decline in the Cboe Volatility Index VIX, better known as the Vix, has helped revive chatter on Wall Street that the volatility gauge is "broken." Some critics have blamed the growing popularity of so-called zero-days-to-expiry, or ODTE, options. Others have blamed the rise of exchange-traded funds that regularly sell options as part of a strategy to generate income.
But according to DataTrek's Nicholas Colas, there's a simpler explanation: The gauge of implied volatility is actually trading exactly where it should be, based on how calm stocks have been over the past 100 trading sessions.
"Actual volatility is low right now and, unsurprisingly, so is the VIX," Colas said in emailed commentary shared with MarketWatch on Wednesday.
The standard deviation of daily S&P 500 SPX returns over the last 100 days is 0.7%, compared with its average of 1% between 2010 and the present day. That's a difference of roughly 30%.
Over the same period, the average level of the Vix has been 18.5. The index stood at 13.3 on Wednesday, meaning the fear gauge is about 28% below its average from the past 14 years.
"The VIX is trading pretty much exactly where one would expect," Colas said.
The upshot of this is that the Vix doesn't necessarily reflect every risk that could send stocks lower. Many have based their criticisms of the index on the sheer number of potential risks facing stocks - from delayed Federal Reserve interest-rate cuts, to geopolitical concerns, to the looming November presidential vote in the U.S., to the possibility that corporate-earnings growth might not live up to Wall Street's expectations.
But this represents a misunderstanding of how the Vix works: Even though it is a gauge of implied volatility, it is not designed to anticipate what comes next, Colas noted.
See: The VIX says stocks are 'reliably in a bull market' heading into 2024. Here's how to read it.
Rather, it merely reflects what has been happening recently in the stock market. This also happens to be the most important factor in the pricing of one-month S&P 500 index options - and the level of the Vix is determined based on trading activity in these contracts.
While the Vix has sunk to its lowest level since late March, a gauge of demand for options tied the index has fallen to an even more notable level. The Cboe VVIX closed at 73.46 on Monday, its lowest level in nearly 10 years, according to FactSet data.
U.S. stocks were trading mixed on Wednesday, with the S&P 500 down 4 points, or 0.1%, at 5,183 in recent trade as the large-cap barometer looked set to snap a four-day winning streak.
The Dow Jones Industrial Average DJIA, meanwhile, was up 74 points, or 0.2%, at 38,959, leaving it on track for a sixth day in the green, what would be its longest winning streak since December.
The Nasdaq Composite COMP fell 42 points, or 0.3%, at 16,290.
-Joseph Adinolfi
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
May 08, 2024 13:13 ET (17:13 GMT)
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