Making Sense of the Stock Market Fear Index

The CBOE Volatility Index is the most widely followed barometer of expected near-term stock market volatility.  The VIX, as it’s called, is often referred to as the “stock market fear gauge,” since it rises when investors become more willing to pay for protection against swift movements—either up or down—in equity prices.

The VIX measures expected volatility based on current pricing of options on the S&P 500 index.  In effect, the more investors are willing to pay for these options—which collectively reflect their sense that stock prices are likely to rise or fall significantly—the higher the VIX will go.

On Wednesday, the VIX closed below 10 for the longest time ever—10 days in a row. Does that mean investors have no fear and markets will stay as calm forever?

Probably not. Today’s unpredictable political backdrop, combined with the fact that US stocks are on their most extended bull run on record, suggest the VIX should be inching up right about now.

However, other forces are at play. A recent Reuters article suggests that the VIX is being tamed by a tranquil environment for stocks, one where macroeconomic news is reasonably solid and largely void of potentially risky outliers, such as the threat of war or a crippling, unforeseen economic event.

Whatever the cause of today’s tranquil trading range, it should not be treated as the new normal. Investors should brace for increased volatility in the months to come.