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Despite gathering clouds, don't bet on a volatility storm

Given lackluster corporate earnings and anemic GDP, you’d think investors would be worried. In turn, you’d think the CBOE Volatility Index (^VIX), or VIX, would be spiking.

Yet that’s not the case; in fact VIX is down sharply over the past 3 months. Although that may seem counterintuitive, Schaeffer’s Investment Research contributor Adam Warner says the price action makes all the sense in the world. People call the VIX Wall Street’s fear index, but “it’s not an emotional gauge,” he noted. “It’s a measure of volatility expected in the market within the next 30 days.”

And looking forward, Warner as well as MIke Santoli of Yahoo Finance, both said options traders see no reason to expect a particularly volatile market in coming weeks. “Summer is coming and in the summer the market tends to go to sleep; it’s a seasonally slow time,” Santoli said.

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Also, Warner added, given the tight range, investors haven’t been hurt by a sharp move lower. “And if options traders haven’t been burned, then they have less reason to buy protection.” All else being equal, weaker demand for protective put options means the VIX should haver a hard time surging and remaining elevated for long. 

Warner, who is also the author of “Options Volatility Trading – Strategies for Profiting from Market Swings,” added that even though volatility is low and therefore premium levels may be enticing, he’s not a fan of playing options as a bet on the next spike, whenever that may be. This is particularly true with listed plays on volatility expectations, such as the popular iPath S&P 500 VIX Futures exchange-traded note (VXX). “Many exchange-traded products tend to decline over time because you pay for time. Therefore, they tend to be a poor long-term investment.”

However, on the flip side of the coin, if you’re concerned about headwinds in the market, with volatility so low, he does think using options as a hedge or a stock-replacement strategy makes sense. “If you want to use options to lock in some gains, then by all means. But I don’t like them for pure speculation.”

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