Best of the Week
Most Popular
1.UK House Prices BrExit Crash NOT Likely Despite London Property Market Weakness - Nadeem_Walayat
2.BrExit Morning - New Dawn for Britain, Independence Day! - Nadeem_Walayat
3.LEAVE Wins EU Referendum - Sterling and FTSE Hit Hard, Pollsters, Bookies and Markets All WRONG! - Nadeem_Walayat
4.BrExit Implications for UK Stock Market, Sterling GBP, House Prices and UK Politics... - Nadeem_Walayat
5.Trading BrExit - Stocks, Bonds, Sterling, Opinion Polls, Bookmaker Odds and My Forecast - Nadeem_Walayat
6.FTSE and Sterling Brexit Trading, Deconstruction of the EU Referendum Result - Nadeem_Walayat
7.UK Interest Rate Cut to 0.25% Imminent and More QE Money Printing - Nadeem_Walayat
8.Trading BrExit - British Pound Plunges, FTSE Stock Futures Slump on LEAVE Shock Referendum Win - Nadeem_Walayat
9.The Stock Market is Reading it Wrong! - Chris_Vermeulen
10.Breakouts Galore in Gold and Silver - Jordan_Roy_Byrne
Free Silver
Last 7 days
Retirees Are Risking Their Life Savings on Junk Bonds - 29th July 16
The Next Recession is Coming - Expect Around 0% Returns for the Next 7 Years - 29th July 16
SPX is Shaking and Rolling - 29th July 16
Stock Market Insiders Are Secretly Selling, Cycle Top Next Month - 28th July 16
FOMC Interest Rates and Their Impact on the US Economy - 28th July 16
The State Of The Economy - 28th July 16
Elliott Wave Crash Course - 3 Ways the Elliott Wave Principle Enhances Your Trading - 28th July 16
Japan's "Helicopter Money" Play: Road to Hyperinflation or Cure Debt Deflation? - 27th July 16
Monetary Zika - The Insidious Nature of Credit Expansion - 27th July 16
Gold and Pork Bellies - 27th July 16
Silver Is Insurance Against The Worst Part Of This Depression - 27th July 16
Don’t Buy The SPX Hope Stock Market Rally! - 27th July 16
Bitcoin $650 Still in Play - 26th July 16
Deutche Bank Stock Price Crash - The EU Has Problems Far Beyond the Brexit - 26th July 16
The Forex Markets Are Getting Exciting! - 26th July 16
Underpriced Silver Is the “Rip Van Winkle” Metal - 25th July 16
Declines in Multiple Market Indexes - 25th July 16
Retailers Are Doomed as Most Americans Are Too Poor to Shop - 25th July 16
Here’s One Currency That Could Go to Zero - 25th July 16
Stock Market Top is Expanding - 25th July 16
Silver Manipulation – Because They Needed the Eggs - 25th July 16
Silver Market COT Stuns: What's Going On Here? - 24th July 16
Gold Demand Remains Stable During Sector Weakness - 24th July 16
Sernova, Diabetes and Haemophilia - 24th July 16
Russia: Tensions, Turmoil, and Western Hubris - 24th July 16
Soybean Commodity Price to Soar Again - 23rd July 16
SPX Stock Market Uptrend Continues - 23rd July 16
Gold And Silver – Debt Addiction Will Carry Precious Metals Higher, Guaranteed - 23rd July 16
Pokemon Go - How to Play, First Use, Balls, Stops, Catching Pokemon's... Great Excercise! - 23rd July 16
7 Signs That the Gold Market Remains Resilient - 23rd July 16
Basic Income in The Time of Crisis - 23rd July 16
Silver Bull Faces Correction - 22nd July 16
The Serious Warning No One’s Talking About - 22nd July 16
Stock Market Insight from Greed, Volatility, and Put/Call Ratio - 22nd July 16
What Will Happen To the Stock Market When Interest Rates Rise? - 22nd July 16
How to Escape the World’s Biggest Ponzi Scheme - 22nd July 16
Addicted to Debt - We Can’t Borrow from the Future Anymore - 21st July 16
Not Everything Is Bullish for Gold - 21st July 16
Don’t Get Sucked Back Into the Stock Market - The Big Picture Hasn’t Changed - 21st July 16
Silver – Caught Inside - 21st July 16
Forex: "The Markets Are Getting Exciting!" - 20th July 16
China Economic Troubles - Is Kyle Bass Finally Getting His Revenge? - 20th July 16
Why Lithium Will See Another Price Spike This Fall - 20th July 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The Power of the Wave Principle

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

Stock-Markets

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 www.cboe.com:


 
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
www.TradersVideoPlaybook.com

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.


© 2005-2016 http://www.MarketOracle.co.uk - 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

Catching a Falling Financial Knife