When Market Volatility Causes Client Fear, Cite the “Fear Factor”Sheaff Brock Institutional
The VIX, ticker symbol for the Chicago Board Options Exchange’s Volatility Index, has the nickname “fear factor.” Paradoxically, a high VIX is not necessary bearish for stocks, you can remind clients, because market volatility refers to upward movements in the market along with downward ones. What a high VIX reading does mean is that investors are seeing significant risk that the market will move sharply, whether up or down. The VIX tends to be low in “ho-hum” times, when investors perceive neither significant downside risk nor significant upside potential. What is actually measured by the VIX is the ratio of put options versus call options being bought on the S&P 500. The VIX, constructed using a wide range of Standard & Poor’s 500 Index options, is a way to express the market’s expectations of volatility over the coming 30 days.
VIX “cheatsheet” for clients:
The CBOE Volatility Index, originally developed back in 1986, was designed to play the same role for options as the S&P index itself plays for stocks. VIX is quoted in percentage points, using a 68% “confidence level.” The price of call and put options is used to calculate the VIX. If the VIX is 15, for example, that would signify an expected annualized change (with a 68% of probability) of the market moving no more than 15% up or down. The VIX trades in a historical range between 10 and 90. At the low end, the indication would be that stock trading is complacent and slow. At the high end, it would mean the market is panicking.
If your financial planning clients are experiencing a market volatility fear reaction these days, that’s no small wonder, concedes Sheaff Brock Managing Director Dave Gilreath. Small wonder—as measured by days with a greater than 1% price move in the S&P 500, this year’s annualized volatility seems remarkably high compared with all of 2017. Investors, watching this fluctuation day by day, combined with headlines about possible trade wars, anemic jobs statistics, and political scandals, perceive there to be high risk in stocks.
Taking a look at the VIX, those clients might draw a different conclusion. The Volatility Index seems to be signaling far more complacence than panic, trading in only the high teens as of this writing.
To be sure, no one has yet invented a surefire method of deciphering which way the stock market is headed. A saying that has been attributed variously to William Bruce Cameron, Albert Einstein, or George Pickering reads: “Not everything that can be counted counts, and not everything that counts can be counted.” The VIX and other models are just “counting tools” investors use to try and better understand the way investment markets function.
When perceived market volatility causes fear in your clients, introduce them to VIX. The “fear factor,” properly explained, can actually help calm those fears!