Why You Should Watch the VIX

03/06/2015 12:01 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

As stocks moved higher in February, the fear levels stayed low, but now MoneyShow's Jim Jubak is keeping an eye on the VIX for a potential profit opportunity in March.

For the week ahead, watch the VIX. The VIX is the Chicago Board of Options Exchange Volatility Index. It's based on how much people are willing to pay for options on the S&P 500. As peoples' feeling about risk goes up, they're willing to pay more, so options go up and the VIX goes up. It's also known at the Fear Index.

In January, we had four occasions when the VIX was near 20. That's not historically high but, for this market where the VIX has really ranged between 25 and say 10, 20 is sort of the top of the range. In January, we had four spikes to 20.

February has been a very, very calm month in comparison and, on March 2, the VIX was as low as 13.04 when it closed. As you can imagine, if you're simply a trader and you're sitting there watching the range of the VIX over the least year or so, it now looks like a good time to put money into, betting that the VIX is going to climb. You've had a calm February, historically low. If you simply moved back from 13 to 20, you'd make a 50% profit.

You can buy ETFs that bet on the VIX, etc. and what we're seeing is money flowing into those ETFs, ETFs and ETNs, which are like ETFs, slight wrinkles, but we're seeing money flow back into them at rates that are as high as the peaks in July of 2013 or even further back. What has been coming out of sort of the inverse VIX ETFs, these are the ones that make a profit if the VIX goes down, so coming out of that, and it's not because there's really any inside knowledge on the part of traders.

It's not like somebody is looking out there and going, oh, there's these big events on the horizon that mean that volatility is about to pick up. I think what you're looking at is pretty much a technical reason for this trade that, if the range is say 10 to 25, putting your money back in when you're down at 13 and expecting a ride back to 20 makes a lot of sense.

If you're coming off a very calm month and you've had a pretty big move in the S&P, up 5.5% in February, then NASDAQ back to its 2000 highs at 5000, all-time highs, so it's logical to think that after those rallies, you might get a correction or at least a selloff or a dip, possibility that the job numbers aren't going to be as good as everyone is expecting that they were, as they were in February.

All of those things make this trade very, very attractive if you simply look at the potential for making a gain. A 50% potential gain staying inside the range, not betting that anything is going to go outside the range, is a pretty good trade.

What this means for those of us who don't active trade volatility, don't trade the VIX, is that you're seeing a pretty big buildup on expectations of some kind of dip, some kind of event, some kind of return of volatility in March. That doesn't mean that that's going to happen, but it does tell you that people looking at the VIX are likely to be taking some profits on the possibility that some of the stocks that have moved up to all-time highs are going to sell off or at least that money is not going to go into them and drive the prices up. It also tells you that if we get a dip and the VIX was to say climb back to 20, you can expect then to see people going, hey, it's time to reverse this trade.

Any kind of dip, at least according to the way I read volatility trades, is likely to be pretty sharp and pretty short. I don't mean 10%, I mean 4% to 5% of this market is a pretty big move, but we could see that kind of thing. It's likely to be relatively short-so short-term trading-betting on the VIX to go up, short-term buying and selling if you're a long-term investor suggests that maybe you want to wait to see what happens with this bet on volatility before you buy anything and that maybe selling to take profits, which is what the market is doing, is not a bad thought to put through your mind for March.

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