Is $VIX “Too Low?” (Preview)

By Lawrence G. McMillan

The title of this article is a question that seems to be asked in many places recently. We have written about this in the past, and our intention in this article is not to re-hash previous discussions. Rather, in this article, we’ll document periods of time where $VIX got low and stayed low for a long while.

Before we get started, let me refresh some conclusions that we have reached before, regarding the relationship between implied volatility ($VIX) and realized volatility (HV20 – the 20-day historical volatility of $SPX). $VIX does not tend to stray too far from HV20, even in market crashes. With HV20 at 7%, where do you expect $VIX to trade? $VIX at 12% is probably where it should be – maybe even a little lower. There is a close relationship between HV20 and $VIX, as there should be. So, to say $VIX is “too low” is not at all correct.

Now, let’s turn our attention to this article. In the financial media recently, there have been several articles that are warning investors to be cautious because $VIX is “too low.” These articles make great fodder for the press, but in general are lacking practical trading sense. Just because $VIX is low doesn’t mean that the stock market is immediately going to collapse. It may be a precursor to some broad market selling further down the road, but a low $VIX is not a problem until $VIX begins to rise out of its “low” state...