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There’s reason to be a bit worried about the broad stock market as we head into the new year.
Last January the market had a historic selloff. And we have an unpredictable new presidential administration incoming, on the heels of a recent strong market rally.
However, one big measure of sentiment among traders is indicating a low level of fear currently.
That’s the CBOE Volatility Index (VIX), which measures the implied volatility on S&P 500 Index (SPX) short-term options. It is a measure of expected market volatility, based on option premium prices.
Volatility Index: VIX is Quiet Now
The VIX is often known as the “Fear Index,” because when investors and traders are concerned about the market, they tend to buy puts as protection from downside moves. This in turn causes the prices of options to rise, and leads to a rise in the VIX.
But the VIX is very quiet right now, at a low level of around 12. When negativity is high, this index tends to go to 20, 30 or higher. For example, during the 2008 market crash, it hit nearly 90, historically high levels.
And this volatility index has been basically moving steadily lower since just after the election. It hasn’t broken above 15 this month.
This contrasts to 2015, where the VIX reached nearly 27 in mid-December and was rising heading into year-end (before the market selloff accelerated in January 2016).
January Selloff?
Similarly, in December 2014, the VIX reached 25 and was moving higher into year-end. And January 2015 then saw a very choppy, volatile month with some big downside moves in the market.
It is important to note that we do have more than a week left in trading year, so we’re not out of the woods yet — expected volatility could still spike higher.
And some analysts view the VIX as a contrarian indicator, which in this case could mean that option traders are complacent heading into year-end, despite potential risks.
But in my view, the current quiet VIX behavior means a big early-January selloff isn’t likely in the cards. It wasn’t a contrarian indicator in 2014 or 2015; it was a “smart money” one.