VIX Index Sending Signal Not Seen In 10 Years
The month of May has been notable for many reasons. Trump scandals grew in proportion, OPEC extended its production caps, global equity markets hit all-time highs and volatility retreat to a low not seen since before the Global Financial Crisis. In most cases a low reading on the VIX, the Volatility Index, is an indication the market has little to fear and that bull market conditions are present. The risk now is, with the index at historical lows, that market reversal could be imminent.
What is the VIX? The VIX is perhaps the single most important financial asset a binary options trader will never trade. Also know as the Fear Index it is a gauge of equity options prices relative to the underlying index which in this case is the broad market S&P 500. There are fear gauges for other indices, most notably the VXN which is based on the NASDAQ Composite. The idea behind it is simple, the prices of options will rise when the market is fearful because traders will place a premium on their stocks. The higher the VIX the more fear and the more chance of correction, reversal or out and out bear market conditions.
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The VIX tends to trade in a range and may trend higher or lower within that range as conditions change. A reading near 15 is considered to be near normal, above 15 things tend to get bearish and below 15 bullish. At this time the index is trending below 12 and very near to the 10 level. The long-term all-time low reading for the VIX is 8.60. The caveat is that the last time the index was so low was during the housing boom of 2006-2007, just before the S&P 500 hit secular resistance, the housing bubble burst and the market entered a time of prolonged bear market conditions.
What traders need to keep in mind is that things are different now. In 2006 the Baby Boomers were still firmly in control of the market and actively selling in preparation for retirement. Considering that Generation X is much smaller than the Baby Boomers, and that the Millennials had not yet begun to get jobs, it is no wonder the market crashed. The basic definition of a bear market is when sellers outnumber buyers and drive prices lower.
Things Are Different Now, Right?
What makes things different now is that the fundamental picture as shifted. There are still some Baby Boomers who’ve not reached retirement age or have yet to retire but they are in the minority. The generation is largely through with retirement selling which leaves the market open for buying and higher prices. Coming in behind them is Generation X and the Millennials who are finally, as a generation, beginning to fully engage with the work force which means one thing; retirement savings, 401K and IRA buying for the next 10 to 15 years will outpace any amount of retirement selling that Generation X can hope to produce. Basically it means a long-term secular bull market.
The takeaway for binary options traders? Don’t be fooled into thinking that a market pullback, consolidation or correction means a bear market is about to start because it likely isn’t. Those times should be viewed as starting points for new, near-term bullish trading with high probability of successful trading.