VIX Levels to Watch

04/26/2013 8:30 am EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Options expert Larry McMillan discusses the recent action in the VIX and what one should be watching as we get further into 2013.

My guest today is Larry McMillan and we are talking about the volatility of the stock market. Hi Larry, and welcome.

Thanks.

So, the market really has not been as volatile recently. I mean, back in 2010 and 2011 we had a lot of volatility that looked da, da, da, da, da. Now, it has sort of more gone on the upward trend. So what do you think about that? Is that going to continue for this year?

Well, yeah, it is hard to say if it continues, but it does present an opportunity for people. I mean, VIX, the volatility index, recently got down to 12.20 or so, which is lowest it has been since May 2007.

The difference between then and now? Then, it was on its way up and we had a lot of problems right after that. Now, it is on its way down. So, as long as it continues to trend lower or stays low, that is bullish for stocks, and stocks continue to rally.

This also is sort of a warning sign that it is this low. So traders and even investors should try to start to think anyway about using some protection. That would be either buying S&P 500 points against their portfolio ,because they are cheap, or buying VIX calls. They are also cheap.

The thing is, you might want to wait until you see volatility actually start to tick up a little bit. In the past, it has sometimes gotten low and stayed low for quite a while. I would suggest right now, it is around 14, it came up from 12 to 14, and if it gets much higher than this—like say 15 and 16—then I would say it is time to get some protection in place, because it might be a sign of trouble ahead.

Is there an average length of time historically that the VIX will stay low? Does that have any meaning for investors at all?

No. I mean, in 2005 and 2006 it stayed low for about 17 months, but other times it has very briefly just come low and then gone right back up again.

We’re seeing the same thing with VIX on SPX options, and we’re seeing the same thing if you look at stock options. The average stock options right now, they are like the fifth percentile of applied volatility, which is extremely low. But, again, as long as it stays low, it is OK. It is just if it starts to move back higher, then we would get assessed.

That is a good warning sign. Now, for the average investor, options still can be kind of scary...but you are not saying they need to go into these esoteric complex options, just in simple puts or a call option on the VIX.

Right, S&P puts or a call option on the VIX would protect your portfolio.

Related Reading:

Searching for Mr. Top

Could Earnings Season Kill the Rally?

Bullish, But Beware Volatility

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