If you are a reader of our weekly Monday Morning Outlook commentary, you are familiar with the observations that I have made about the tendency of the CBOE Market Volatility Index (VIX – 16.51) to put in tops that are around 50 percent (give or take) above the prior lows since early 2012. The most recent example was the February peak at 18.99, after bottoming at 12.31 the week prior. The one major exception was May/June 2012, when the VIX’s peak occurred around double the prior low. In this week’s trading, the VIX has again rallied to an area 50-percent above 2013 low.
On March 15, the VIX put in its 2013 intraday low at 11.05 and closing low of 11.30. Therefore, 50% above the intraday low is 16.57 and 50% above the closing low is 16.95. With the VIX closing at 17.27 on Monday and 16.51 yesterday, the expectation is that it grinds lower from here. But if this area does not mark a top, you can brace yourself to a move to at least the 22-23 area, or double this year’s low.
The chart below depicts recent major lows (circles) and the various horizontal lines mark the area that is 50-percent above the low ahead of the spike. This is a good illustration of what we have noticed with respect to VIX price action over the past several months. A theory is that this 50-percent above prior low is a threshold for determining how expensive portfolio insurance has become. If portfolio insurance is perceived as expensive, portfolio protection seekers may be less apt to purchase index and exchange-traded fund puts, actions that create a headwind for the market, since sellers of the puts will hedge by selling equity index futures.
Yes, I know, it almost sounds too simple. But sometimes simplicity trumps complexity, especially when increasing volatility creates confusion among market participants. That said, and like anything else, it isn’t automatic, as even great basketball players miss the simple lay-ups.
Circles mark key VIX lows and the horizontal lines mark areas 50-percent above the prior low