The Dynamic Between Price and Volatility

One thing we have noticed over the past few months is a lack of response by volatility, or the VIX when markets move sharply higher or lower.  It is common to see volatility leading price, which is why the VIX is such an important indicator.  But lately we have seen minimal movements in VIX when the markets soar or get drilled, and that has led some to believe the VIX just doesn't work. Of course, that could not be further from the truth - the VIX is simply an indicator and tells us a great deal of information about what is happening in the moment.

 

But when stocks are falling, the VIX usually picks up.  Protection is being bought as fear levels rise.  But that is not the case, in fact just this last week when we saw a massive reversal following the Fed decision (Nov 2 the SPX 500 rose up 40 points and then fell 135 points) the net move in the VIX was a whopping 5 cents up. No fear at all.  

 

Let's remember an elevated VIX simply means big ranges for the indices.  With the VIX at 25, by rule of 16 we should expect about 1.6% moves on a daily basis.  If it fails to move that much the VIX could decline, leading to higher stock prices.  But that move last Wednesday was far more than 1.6%, in fact it was more than double that amount, or 3.5%.  Yet the VIX barely budged.

 

It's hard to explain behavior at certain points in time, but it seems two things are happening.  First, those who want protection already hold it.  So there is not a demand for volatility as it relates to the VIX and SPX options (purchasing puts on the index).  Second, while the economy seems to be heading toward a slowdown with higher rates, quantitative tightening and inflation - these are not a surprise - it's already known.  The VIX rises up when shocks hit the market/economy and adjustments need to be made to portfolios.  

 

Hence, the volatility in the market is not leading stock prices right now.  Back in 2020 when the consequences of the covid19 pandemic were first being analyzed, the 'doomsday' scenario was being priced in, capital was removed swiftly and stock prices crashed until calmer heads prevailed and a slew of liquidity came into the market.  

 

With today's VIX movement vs stock price action and what is known, there is not a setup for a stock market crash to occur in the near term (unless some black swan event arrives).  However, it does not mean stocks won't go lower, it'll just mean when they do fall, rising up will be that much more difficult as lower ranges will be the norm.