The VIX Becomes Worthless (VXX, VXZ)

The CBOE Volatility Index, or the VIX, has become almost a useless barometer in the current environment.  With the VIX’s nickname being called “The Fear Index,” this is probably no huge surprise based on 50% and 60% index gains from the March 9 closing bell levels.  The VIX shows the expectation of volatility for the month ahead and is constructed using the implied volatility of a range of S&P 500 index options from both call and put contracts.

The iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX) and the iPath S&P 500 VIX Mid-Term Futures ETN (NYSE: VXZ) are the two exchange-Trade products which trade around the VIX.  The lower and lower the VIX heads, the less and less worried investors seem to be.  With the VIX hitting a 52-week low of 20.91 today, that means that investors’ fears are also at a 52-week low.  When you consider that the VIX went to an all-time high of 89.53 earlier this year, it is obvious how short the memory of traders really is.

The sad part is that through time many felt as though 20.0 was the pivot point.  And then the extremes went up as high as 40 where you had to get close to before a major inflection point was reached.  What we saw in late-2008 was a re-definition of the fear index extremes.

Maybe the VIX will head back toward lows, which means that investors are feeling less and less fearful.  Or maybe it rises.  But the VIX has not been above 30 since early July.  While it came close to 30 in late-August and then again at the end of September, we are not at 52-week lows.

As far as we are concerned, the VIX can head down to 15 or back up to 25.  Most traders have only been able to use the VIX when it is rising and when it gets back above the 30 reading historically for major inflection points.  Even then, we saw how that notion was blown out of the water last year and in early 2009.  For now, you might as well throw anything about the VIX in the garbage can.

There is at least one other notion when the VIX starts to reach very low historic levels.  Buying downside protection gets very cheap.

Jon C. Ogg
October 19, 2009