The VIX Breaches The Key 20 Level

As option traders and market timers, one of the key indicators that we’ve been watching and analyzing since the early-1990s is the CBOE Volatility Index (VIX) (VXX). The VIX measures the implied volatility of S&P 500 (SPX) options and is basically the original way to measure market sentiment levels among option traders (both retail & institutional).

This is because the moves in the VIX & option implied volatility are governed by the actual underlying volatility, news events, market action, etc — but also buy supply & demand. Basically, especially in times of uncertainty, option buyers can push implied volatility higher — generally because they are buying Puts for protection (or buying Volatility/Vega in general). The rule of thumb is that the VIX will rise when the market falls and vice-versa — hence why it is often looked at as a panic and/or sentiment indicator.

What developed this week thus far is that the VIX closed below the round 20 level yesterday, basically having somewhat of an ‘implosion’ following election news in Greece and other developments in Europe. See the first chart below.

You can see that the VIX has primarily been in some fairly clearly defined ranges over the past 12 months — 20 to 24/25 and 15 to 20. Monday’s VIX close down to 18.32 was the first close below the round 20 level in a over a month. Staying back in this 15 to 20 range should provide a backdrop to further gains in stocks, in my analysis.

Don’t forget there are many looming Euro finance type problems in Europe that can come back and rear their heads still this year — as well as worries about the US economy. But “the chart tells the tale” as we say, and the shorter-term VIX reading is saying that some of the negative sentiment & pressure has cooled off. Quick note on the major US stock index ETFs (SPY) (QQQ) (DIA) (IWM) — using our favorite market timing indicator modified %R, none of these has quite yet reached a strongly bullish reading, but they are approaching one.

VIX Daily Chart

Stepping back to a Weekly VIX Chart over the past couple of years (remember that the 2012 market has thus far been very to similar to 2010 and 2011 in many ways), you can see on the chart below that 15 has been a clear bottom for the VIX. So the range is pretty defined at this point in my view — 15 has been downside support and 20 is an important level to stay below (for bulls). With all the global uncertainty, a move below 15 back down to levels like 12.5 and 10, seems unlikely for the next few months.

VIX Weekly Chart

Bottom Line:  The VIX break below 20 is significant, assuming it stays below there this week.  But don’t forget there are many looming Euro finance type problems in Europe that can come back and rear their heads still this year — as well as worries about the US economy.  However “the chart tells the tale” as we say, and the shorter-term VIX reading is saying that some of the negative sentiment & pressure has cooled off.  Quick note on the major US stock index ETFs (SPY) (QQQ) (DIA) (IWM) — using our favorite market timing indicator, modified %R, none of these has quite yet reached a strongly bullish reading, but they are approaching one.