Monday, the Volatility Index (VIX) almost dropped for the eleventh consecutive day, which would have been a record streak. Yet in the end, the VIX moved up. Still, a 10-day declining streak for the VIX remains a very rare occurrence. Such long streaks have coincided with further upside for stocks in the past.
Daily Options Report: “Looking at the other fifteen instances in which the VIX fell at least seven days in a row, a pattern emerges in which following the VIX streak, the S&P 500 index has a tendency to post a slight loss for a week or so, then significantly outperform the historical averages (“census”) for the balance of the periods studied, from 10 to 100 trading days.”
Whatever the future performance of stocks, the Options Report also highlights the fact that options markets repeatedly over-estimated the actual risk of stocks this year (by which we mean the financial definition of risk, ie. the degree of positive or negative price movements for an asset).
This is seen by the long VIX downtrend year to date.
Basically, the drop in volatility has gone in a stairstep fashion. The market gets comfortable at a VIX level and sits for a couple cycles before hitting new lows. At all times, it overbid actual risk.
Clearly that overbid dimishes as the VIX drops in absolute terms. In other words, there’s not much further to go, this may be the last step for all we know.
We’ve said it before, but if you are truly bearish, then a falling VIX means put protection for your winners has gotten cheaper. Thus the incentive to hedge your longs is rising, especially given the stock market’s gains. For the right stock, with the right option price, there might be some great deals right now; it is worth a look.