Implied Volatility Indexes and Fear Indicators
Updated: Apr 3, 2020
As the COVID-19 virus spread through the world from Feb-Mar 2020 Wall Street’s fear gauge, the VIX Index spiked to its highest levels since the global financial crisis turmoil. VIX is considered by many to be U.S. stock markets “fear index.” Extreme highs indicate widespread fear by investors, and as a contrarian indicator it is interpreted to be a positive sign that the market may have bottomed. Extreme lows denote widespread complacency, which is interpreted as negative for the market. In the wake of the market’s plunge last week, VIX has soared to 85.47 (3/18/20) or just below its Oct 2008 high (89.53). VXD or Dow Jones Industrial implied volatility index also exploded to 71.05 (3/18/20) or slightly below its Oct 2008 high (80.24). The NASDAQ 100 implied volatility index (VXN) also traded to a 11-year high of 84.67 (3/18/20) or marginally below its Oct 2008 high (86.52).
So, did VIX, VXD, and VXN just flash contrarian buy signals on 3/18/20? And what will it take for the implied volatility indexes to return to normal volatility? Enclosed below we delved into the three popular indexes and identify key technical levels. When these volatility indexes return to normal this will likely signal major market bottoms and the start of sustainable intermediate-term recoveries. Remember, internal highs and internal lows are important technical signs of inflection points in the marketplace. That is, key technical indicators often flashed advanced signs of extreme conditions just prior to major market bottoms and market tops. However, the signal does not necessarily mark the final top/bottom in the market. Rather, it is the actions in the subsequent days, weeks, and months after setting the extreme readings that confirm a major market bottom or top. Summarized below are technical views of VIX, VXD, and VXN.
S&P 500 Index Implied Volatility (VIX – 63.95)
VIX (63.95) or the S&P 500 Implied Volatility Index recently traded to a high of 85.47 (3/18/20) or just below the Oct 2008 high (89.53). This fear indicator signals the similar type of extreme fear last witnessed during the height of the global financial crisis on Oct 2018 or soon after Lehman Brothers filed for bankruptcy (9/15/08). It is important to point out that despite recording an internal high in the VIX Index during Oct 2018, SPX (price) continued to decline for another 5-months finally bottoming on Mar 2009 (666.79). Notice that after setting a high on Oct 2008 (89.53) there were a series of lower highs in the VIX including Nov 2008 (81.48), Dec 2008 (68.60) and Mar 2009 (53.25). Fast forward today, we are encouraged by the recent VIX high of 85.47 (3/18/20). It is now trading at 63.95. However, the reading remains relatively highs suggesting that there are still considerable fear and concerns circulating among investors/traders. If VIX repeats the same scenario as global financial crisis by establishing a series of lower-highs over the next few weeks/months this will greatly help with the process to define a major market bottom in SPX. It is also important that VIX decline decisively below 50.30-53.29 (Mar 2009, Aug 2015, and Feb 2018 highs) as this would begin reverse the recent high volatility trend and trigger investors to return to the marketplace further reinforcing a major SPX bottom.
Also enclosed is a monthly SPX chart that shows two technically significant levels including the Dec 2018 monthly low (2,506.85) and the 2009 uptrend line breakdown (2,663). It is constructive that SPX maintains above these two key technical supports. The ability to retain these two technical levels can lead to a SPX recovery that retests key resistance at 2,824-2,946 (Jan/Sep 2018 and Apr 2019 highs). Above this level confirms the resumption of the primary long-term uptrend.
Dow Jones Industrial Implied Volatility (VXD – 65.22)
VXD (65.22) or the INDU Implied Volatility Index reached a recent high of 71.05 (3/18/20) or slightly below its Oct 2008 high (80.24). It is stunning that in less than 3-months VXD jumped from a low of 2.47 (Jan 2020) to 71.05 (3/18/20). This is substantially faster and sharper than during the global financial crisis as VXD rallied from a low in Nov 2006 (7.36) to a high in Oct 2008 (80.24). Like VIX Index once VXD established an internal high (80.24) coupled with a series of lower-highs including Nov 2008 (75.33), Dec 2008 (63.03) and then Mar 2009 (47.29) this sets the stage for the final INDU bottom (6,469.95 - 3/2/09). If VXD can again set a series of lower-highs over the next few weeks/months and trades convincingly below 40.21-47.29 (Mar 2009, May 2010, Oct 2011 and Feb 2018 highs) this can lead to lower volatility as buyers return to INDU thereby defining a major market bottom.
INDU remains the weaker of the large-cap U.S. market indexes (SPX and NASDAQ) as the monthly chart shows two key violations of major supports below the Dec 2018 close (23,327.46) and the 2009 uptrend (22,028). Based on these two key technical breakdowns INDU need considerably more help. This blue-chip index must first surpass these key technical levels to signal the start of a recovery. It also needs to clear above pivotal intermediate-term resistances at 26,100-26,600 (Jan/Sep 2018 and Apr 2019 highs) to confirm the resumption of its primary long-term uptrend.
NASDAQ 100 Implied Volatility (VXN – 60.99)
VXN (60.99) or the NASDAQ 100 Index Implied Volatility also traded to a 11-year high of 84.67 (3/18/20) or marginally below its Oct 2008 high (86.52). Note that during the Tech/Telcom Dotcom crisis VXN traded to an extreme high of 93.17-99.35 (Apr 2000/Sep 2011). So the pertinent question then becomes do VXN need to revisit the extreme highs of Tech/Telecom time frame before a NDX bottom occurs or is the recent Mar 2020 rally (84.67) to just below the Oct 2008 high (86.52) sufficient to establish an internal high in VXN?
To attract momentum type and growth investors to return to NDX, VXN will need to decline below 46.72-51.46 (Mar 2009, May 2010, Oct 2011, and Aug 2015 highs), and preferably below 34.75-40.77. A calmer and less volatile NDX will lure buyers back to this leadership market.
Although NDX has broken its 2018 breakout (7,983) it continues to retain its long-term 30-month ma (7,339). It is also currently trading comfortably above its 2009 uptrend channel (6,914/6,142) as well as its Dec 2018 low (6,330). This suggests NDX retains its leadership role. When VXN begins to return to normal volatility (below mid-30s to mid-40s) this is likely to trigger the next major NDX rally.