Daily Update: Still Volatile (Just Not Extreme)

If commodity prices aren’t factoring in an imminent recession, what’s going on? Looking deeper, I’m inclined to blame bad market habits.

The VIX is known as the fear index. However, it’s calculated on statistics and not sentiment . . . measuring the amount of implied volatility built into prevailing option prices.

When options prices go up, traders are expecting stocks to move a lot farther in either direction before those options expire. Otherwise, those puts and calls don’t make money.

And when those options prices go up, that’s what the VIX measures. Usually stocks are at or near record levels so the direction of the implied move tends to be down. People will pay a lot more for puts because the odds of trading profit are higher.

That means a rising VIX is generally a measure of fear. But when the VIX comes down from extreme levels like what we’ve seen recently, it reflects distortions throughout the market.

Remember, a lot of people are locked into a binary “risk on / risk off” mindset now. The Fed statement broke the “risk off” flight from stocks in general . . . and so the VIX is finally coming down.

But we’ve talked about the way money always needs to go somewhere. As safe havens become less popular (for the time being), the money flows back to risk assets.

Tech stocks are the primary risk asset these days, so we see them rally. And commodities were the primary haven from inflation and a vindictive Fed . . . we’re seeing money flow out of that end of the market.

It’s just what happens when the VIX recedes. I’d love it to drop to normal levels so we can get an authentic view of what assets are worth in the post-pandemic world.

For now, that’s a long way away. We haven’t seen “normal” VIX levels (below 15) in years.

That’s been great for options traders. I’m not complaining! But it will be nice to see the binary “on / off” switch replaced with something more reasonable and realistic: money rotating across themes without swinging wildly to extremes.

Those extreme swings, after all, are what the VIX measures. A little more moderation is good for those who want to catch their breath now and then.