What to Know about the Volatility Index (VIX)

Any time the VIX drops under 10 it becomes a buying opportunity.

We noted as much in late July 2017, as the VIX traded at just 9.36:

“While many don't pay attention to such a gauge, as markets rally, it’s well worth paying attention to. You see each time the VIX has closed below 10, we’ve seen big spikes in volatility shortly after,” we said.

We’re no strangers to that argument.  We’ve used it countless times. 

When the VIX dropped below 10 in June 2017, it exploded from 9.75 to 13 days after, resulting in a pullback in major indices, too.  In May 2017, the VIX hit a low of 9.57, suggesting it was only a matter of time before volatility spiked again.  Not long after it took off from 9.57 to 15.71.

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The problem with the VIX under 10 is that it’s a sign of calm.  Every one thinks all is okay.  Folks continue to buy just about everything on the idea that nothing troubling is on the horizon.  Many fail to seek protection.

But when the VIX drops under 10, it’s a sign to protect your portfolio.

In early August 2017, the markets hit new highs of 22,179.  The VIX was still under 10.  No one expected anything was wrong.  Analysts were still telling traders and investors that they still had plenty of time to buy the rally.  It was far from over, many noted.

Not long after –as tensions boiled with North Korea- the VIX exploded to 15.36.  The Dow Jones slipped about 200 points in just days.  Any one that wasn’t prepared for even the potential for failure lost money.

It happened again in early December 2017, even as markets exploded higher. 

Here’s a one-year chart of the VIX with overlays with Bollinger Bands, MACD, relative strength and Williams’ %R.  Look at what happens when they each agree that a volatility spike is overdone.  We begin with a look at VIX at upper Bollinger Band (2,20).  It has a tendency to fail at that point.  The “rubber band” has been pulled too far.

Since May 2017, this has been proven again and again, and can be used to your advantage.  To trade such an event, we can always buy call options on the VIX, for example.  Or, we can even use ETFs, too with the Pro Shares Short VIX Short-Term Futures ETF (SVXY) and the Velocity Shares Daily Inverse VIX Medium-Term ETN (ZIV).

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