The primary determinant of put and call option premiums is implied volatility, or the price variance the market expects over a coming period. The VIX index is a compilation of the implied volatility of options on S&P 500 stocks. The VIX tends to move higher during bearish periods and lower when the diversified stock market index moves higher. A rising VIX reflects increased demand for price insurance to protect portfolios. During rallies, market participants tend to sell put and call options to enhance returns.
The VIX range over the past years- In 2023, the VIX trends lower
The twenty-year chart displays the VIX’s range over the past years:
In 2020, the VIX traded from an 11.75 low to an 85.47 high, the highest level since 2008 when the VIX reached 89.53 during the global financial crisis. In 2021, the volatility index range was as low as 14.10 and as high as 37.51. Last year, the range was from 16.34 to 38.93 as the VIX traded from the high to the low in January 2022. Over the rest of last year, the VIX remained inside that range. In 2023, it has been as high as 30.81 and as low as 12.73, the lowest level since before the 2020 global pandemic.
Markets reflect the economic and geopolitical landscapes
The U.S. economic, political, and geopolitical landscapes remain a mess in late August 2023. Markets across all asset classes, including the stock market, move higher or lower because of the state of the domestic and global landscapes.
As markets head into the final months of this year the following factors are causing more than a bit of uncertainty:
- In the U.S., inflation remains double the Fed’s target 2% level, meaning interest rates will stay high and the central bank could boost them by 25 or 50 basis points by the end of 2023. Higher interest rates weigh on stock prices as bonds compete with stocks for investment capital.
- The U.S. Presidential election will kick into high gear over the coming months. Despite his historically low approval rating, the incumbent President is a virtual lock for his party’s nomination. While the Republicans have a wide field of candidates for the nomination, former President Trump has a massive lead in the polls despite indictments in four jurisdictions.
- The war in Ukraine continues to rage, bifurcating the world’s nuclear powers and threatening worldwide peace. Relations between Moscow and Washington DC continue to deteriorate.
- China and Russia continue to operate under a “no-limits” alliance. China’s reunification plans with Taiwan have caused relations between Beijing and Washington to deteriorate.
- Iran and North Korea have become nuclear powers allied with China and Russia.
- The potential for a BRICS currency that challenges the U.S. dollar’s role as the world’s reserve currency for cross-border payments will change the worldwide financial system, reducing the U.S.’s dominant position.
These factors and the potential for surprises pose significant threats to markets and could cause sudden volatile price spikes over the coming months that send stock prices lower and lift the VIX from its current neutral level.
The VIX’s base level has been risingWhile the trend in the VIX has been choppy since the 2020 global pandemic, the path of least resistance displays a higher base price since before the pandemic.
The chart shows that after reaching an 8.56 low in November 2017, the VIX has remained above the 10 level. While it is currently sitting between 14 and 16, the base level has increased over the past years, which tells us the volatility index indicates more concern about sudden stock market selloffs.
Unexpected events can cause the most significant VIX moves
Unexpected events tend to cause the most substantial increases in the VIX index as they catch market participants by surprise and lead to a sudden rush for price insurance to secure risk portfolios.
The first example came in 2008 when the global financial crisis blind-sighted the stock market and caused the VIX to explode to nearly the 90 level, a record high. The next explosive move occurred in 2020, taking the VIX over 85 as the global pandemic shocked the world and markets across all asset classes. Russia’s invasion of Ukraine was another surprise that lifted the VIX over the 35 level.
The historical trading pattern shows the VIX spikes higher when unexpected events occur.
The VIX is sitting at a neutral level today- The odds favor sudden rallies
At the 14-16 level in late August 2023, the VIX is sitting in neutral territory as the trend in the S&P 500, the most diversified U.S. stock market index, remains bullish.
The S&P 500 chart shows the over 16% rise in 2023. The rising stock market has weighed on the VIX, but even as the S&P 500 approaches a record high, the VIX remains higher than the 2017 low.
The economic and political factors facing markets remain why the VIX will stay elevated, and the odds favor higher instead of lower levels for the volatility index for as far as the eye can see.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
