Since the beginning of August, if the whipsawing of stocks didn't shake you out of the market and you just hung in there, you'd be down about 12% right now. However, had you owned the CBOE Volatility Index (VIX) during that same period of time, you'd be calling your friends to remind them what a genius you are since you would have doubled your money.
For those who merely monitor the VIX in an effort to gauge the mood and direction of the market, it has been sending some wild signals lately, most of which suggest that we've got more troubles ahead of us.
"The message is we could see a significantly more uncomfortable environment," says Jim Strugger, derivatives strategist at MKM Partners. He points out we are currently experiencing the highest level of volatility we have seen since the 1940's when you exclude the spike to 72 in 2008 and the crash of 1987.
Even the front page of the WSJ today addresses the "head snapping" volatility of late, saying the trouble is probably not over and that extreme swings in the markets have forced out long-term investors, leaving only hedge funds and high-frequency traders to duke it out.
For Strugger, there are several key levels to watch in the VIX. He says once it ticks above 20, things get wide "open to the upside." The next key level to watch is 35, since that has marked the peak of several shocks to the market since 1990. What happens if the VIX spikes above its Aug. 8 high of 48?
"It means the market will see downside and remain volatile for a much longer period of time," Strugger says. He backs up his thesis by noting that in Fall of 2008, the VIX peaked at 80, and stayed above the 25 theshhold for nearly 10 months.
While many institutional clients are 100% hedged, or protected, from these shocks, professionals say every investor needs to be hedged to some degree.
"In this environment, I view it as a period where people should be much more focused on risk than return," Strugger says, adding that a move back below 25 again is the ''green light" investors should wait for to buy stocks.
6 comments