Best of the Week
Most Popular
1.War on Cash, Bank of England Planning Hyper QE, Scrapping Cash for Digital Currency - Nadeem_Walayat
2.Stock Market End Run Smash Crash Looks Imminent... - Clive_Maund
3.Europe Refugee Crisis, UK to Repatriate 120,000 Hungarian Economic Migrants Back to Hungary - Nadeem_Walayat
4.The Great Deflation Will Destroy All Bubbles – These Too - Harry_Dent
5.Deflation Signals Abound for U.S. Dollar, Forex Markets and Commodities - Rambus_Chartology
6.U.S. Housing Market Two Outs in The Bottom of The Ninth - James_Quinn
7.Poland, Czech, Slovakia and Hungary Refugee Hypocrisy After Flooding UK with 4 Million Economic Migrants - Nadeem_Walayat
8.The Two Real Reasons Crude Oil Prices Are Currently Slipping - Dr. Kent Moors
9.R.I.P. Interest Rates - Andrew Snyder
10.Steps from a Deep October Stock Market Selloff - Bob_Loukas
Last 5 days
Theresa May Declares War on Immigration - Conference Speech Full Transcript - 6th Oct 15
Is Russia Plotting To Bring Down OPEC? - 6th Oct 15
Target Date Funds As Aid In Retirement Investment Portfolio Design - 6th Oct 15
Stocks Bear Market Apocalypse Imminent Crash Gets Nuked Again - 6th Oct 15
Redesigning Internet and Facebook to Explore Their Full Potentialities... - 5th Oct 15
Nightshades Curb Your Enthusiasm - 5th Oct 15
U.S. Recession Watch, High-Yield – Rising Defaults - 5th Oct 15
The Social Challenge to Find Humanity in Capitalism - 5th Oct 15
Fed Interest Rate Hike: "I don't care. It doesn't really make much of a difference" - 5th Oct 15
Gold Rose 2.2%, Silver Surged 5.4% After Poor Jobs Number On Friday - 5th Oct 15
Gold, Silver Precious Metals: a Critical Week Ahead - 5th Oct 15
Stock Market Correction Still in Force - 5th Oct 15
Gold Price Change in Character - 5th Oct 15
Putin’s Blitz Leaves Washington Rankled and Confused - 4th Oct 15
More Selling for Stock Market, Gold? - 4th Oct 15
Gold And Silver – A Reality Check - 3rd Oct 15
Stock Market Primary IV Still, or Primary V Underway? - 3rd Oct 15
The Oil Industry’s Day of Reckoning - 3rd Oct 15
U.S. Interest Rate Hikes Keep On Slippin' Into the Future; Treasury Yields Sink Again - 3rd Oct 15
China's Stock Market Crashing; Time for Panic or Restraint - 3rd Oct 15
SPX Stocks Bulls Struggle to Regain the Upper hand... - 2nd Oct 15
The Two Faces of Stock Market Volatility - 2nd Oct 15
Money Supply and the Fed’s Serious Inflation Risks - 2nd Oct 15
Stock Market How Bad Can This Get, And How Fast? - 2nd Oct 15
A Worrying Set Of Recession Signals - 2nd Oct 15
Negative Jobs Report Sents SPX, TNX Lower - 2nd Oct 15
Don't be Fooled by the Recent Equity market Rallies. Its a Bear Market, Stupid! - 2nd Oct 15
US Bond Market - How to Fix This - 2nd Oct 15
Survival Secrets from Colorado Resource Investing Front Lines - 2nd Oct 15
What Two Risks From Rising Interest-Rates Could Each Trigger A New Global Crisis? - 1st Oct 15
Stock Market S&P 500 Volatility-Based Price Probability Range - 1st Oct 15
Dow Stock Market About To Crash Like October 1929? Get Your Physical Silver - 1st Oct 15
Stock Market Negative Expectations Once Again - Will It Break Down? - 1st Oct 15
Advice for Biotech Investors: 'Hold Your Powder' 'til Winter - 1st Oct 15
Best Short-Term Commodity Market Opportunities - Video - 1st Oct 15

Free Instant Analysis

Free Instant Technical Analysis

Market Oracle FREE Newsletter

What the Stock Market VIX is Saying About the Fiscal Cliff

Stock-Markets / Stock Markets 2012 Dec 07, 2012 - 09:24 AM GMT

By: J_W_Jones


The past few weeks have been full of a constant barrage of press conferences and public statements from the charlatans in Washington D.C. Politicians cannot pass up a chance to get in front of the cameras and the media has used the “fiscal cliff” as a mechanism to scare average Americans further about their future.

Interestingly enough, amid all of the nonsense that has been going on stocks have remained resilient. I think sometimes its important to just step back away from the media's noise and just look at some price charts for more clarity. The S&P 500 Index has been trading in a relatively tight range now for over 6 trading sessions as shown below.

As can be seen above, the S&P 500 is struggling to breakout of the 1,400 – 1,420 price range. It is not mere coincidence that the Volume by Price indicator is illustrating the most trading volume having occurred in and around that price range. So what does the recent action mean in light of the supposedly pending fiscal calamity?

Everyone that is looking for this monster move when the announcement is finally made may be waiting for a while. It is without question that the broader marketplace is clearly aware of the fiscal cliff. It would make sense that Mr. Market may have priced in some of the uncertainty. Furthermore, if there was significant concern we would be seeing prices starting to sell off by now.

Markets do not like uncertainty. However, what is certain is that during the end of the year the bulls usually have the upper hand. The reasons are fairly simple, but they usually hold sway most years. Due to the holiday season, many traders take vacations and leave their trading desks. Because traders are largely absent, volume levels start to decline as the holiday season approaches. Typically volume levels do not normalize until January of the new year.

Low volume levels typically synch up with low volatility levels. When those two forces align together the bulls will almost always have the upper hand. Is it any wonder that this time of year the financial media begins discussing a “Santa Claus rally”? Of course not, but Santa Claus is really just light volume levels and low volatility levels in this case.

Recently volatility has been pretty choppy, but the Volatility Index is not showing considerable fear regarding the fiscal cliff in the near term. In fact, the VIX is trading in the middle of its recent range as shown below.

At first glance, this chart does not appear to be warning us about fear at the moment. However, certain aspects of the Volatility Index (VIX) are largely unknown to the retail investor. The VIX is a guide for volatility in the present, but it does a poor job of projecting future volatility. Simply looking at the VIX's current price is not the appropriate way to gauge market volatility expectations in the future..

The Volatility Term Structure is a better way of understanding what the Volatility Index is saying about the future. Wikipedia lists the following definition for volatility term structure:

             “Volatility term structures list the relationship between implied volatilities and time to             expiration. The term structures provide another method for traders to gauge cheap or expensive       options.”

The current Volatility Term Structure chart is shown below courtesy of

As can be seen above, the forward Volatility Term Structure indicates that volatility is expected to go higher in the future. This is not all that uncommon, but I think what is more important is the rate of change in the near term.

When we look at this chart, the term structure indicates that Volatility levels roughly 4 months  out (March 2013) are nearly 13% higher than they are today. By June of 2013, volatility's rate of change is well over 20% higher than it is today.

It is important to understand that volatility does not necessarily mean risk. Volatility typically increases when equity prices are falling, however volatility levels can rise for a variety of reasons. Uncertainty about the outcome of an event like hitting the debt ceiling could push volatility levels higher without sending equity prices sharply lower. The point is the term structure just provides clues as it is not the holy grail about looking in the future.

What the Volatility term structure does tell us is that the marketplace expects a significant increase in overall volatility in the next 3 – 6 months. What I think the Volatility Term Structure is conveying presently is that decisions regarding the fiscal cliff and the debt ceiling will impact market prices, However the real impact may not be felt until later in the 1st or 2nd Quarters of 2013.

Most economists believe that if we do go over the fiscal cliff and taxes go up for everyone that the U.S. economy will be in recession within 6 – 9 months. Clearly as shown above, the Volatility Term Structure likely agrees with the economists assessments and the economic conditions in the next 6 to 7 months could possibly turn for the worse.

All we can hope for is that the politicians can compromise on a plan that will remove uncertainty from the marketplace without compromising the economy. Something tells me that is not likely to happen, but here is to hoping that I'm wrong!

Happy Trading!

Risk-FREE 30-Day Trial

only $1 for the first 30 days!

JW Jones

J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. J.W. strives to reach traders that are missing opportunities trading options and commits to writing content which is not only educational, but entertaining as well. Regular readers will develop the knowledge and skills to trade options competently over time. Jones focuses on writing spreads in situations where risk is clearly defined and high potential returns can be realized. 

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

© 2005-2015 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Biggest Debt Bomb in History