My apologies to anyone who read this weekend’s newsletter and wasn’t familiar with the CBOE Volatility Index, or the VIX. I sometimes forget what’s getting processed in my head isn’t necessarily implanted in yours. Since I plan on keeping close tabs on the VIX in the near future, let’s go ahead and look at what it is exactly.

The Chicago Board of Options Exchange designed an indicator a couple of decades ago that was intended to predict near-term volatility. It was called the VIX, or volatility index. The higher the VIX went, the more volatile the market was supposed to be over the next one to three months. The volatility expectation was determined by a change in options prices, which tend to increase or decrease with volatility…..presumably.

What the CBOE found was the VIX didn’t respond the same way to bullish volatility that it did to bearish volatility. As bearish periods started, the VIX moved higher. When bullish periods started, the VIX sank. It was not a predictor of volatility, but rather became a ‘fear gauge’. A Higher VIX meant investors were fearful, and a lower VIX meant investors were complacent.

As long as fear and complacency were nominal, no big deal. It was observed, however, as fear and greed hit extremes - when the VIX hit its extremes - that the market was likely to be at a point of reversal. That’s why we’re not expecting a major upside move just yet…there’s not been a good, solid peak in fear yet.

Is it a flawless strategy? No, but look at the chart below….it works more often than not.

Bottom line: The VIX is a fear gauge. That wasn’t quite what it was designed to be, but that’s how it’s been regarded almost since its inception. Moreover, it’s a pretty good contrarian tool to utilize.

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