The VIX futures market sees increased volume

The Chicago Board of Options Volatility Exchange Index (the VIX) has seen increased futures trading volume lately. Some see this as a sign of a looming stock market pull back while others say this is a positive sign for those invested in equities. 

that’s a complicated way of saying: Investors are buying more futures contracts on the VIX which suggests its price is going to go higher (currently it is fairly stable and trades near its 52 week low). Historically an increase in the VIX has meant a corresponding decrease in the stock market. However some traders and analysts argue that this time it means the market will continue to move higher.

What is the VIX? Volatility is the movement of the price of a stock. Doesn’t matter if the price goes up or down, only that it moves. The greater the stock moves the more volatile it is. Note, the stock market is ALWAYS volatile. It changes every day it is open. But some days it changes significantly more than others. The VIX measures the amount of “implied volatility” of stocks for the next 30 days by examining their option contracts. When the spread of the price of options grows larger, this signals that stocks are more likely to experience a change in price. A change in price is the same as saying the stock will experience increased volatility.

Lately, investors and traders have been buying more futures contracts on the VIX. Because the VIX is low, this suggests that they expect the price of the VIX will increase. Since the 2008 market crash, an increase in the VIX has usually been tied  to an immediate decline in the price of stocks. Because traders see the price of the VIX is expected to rise (by looking at the VIX futures market) some will undoubtedly begin to close their positions in stocks and move into lower risk investments in an attempt to sell before the market pulls back (like it has of late). This could potentially act as a self-fulfilling prophecy: traders selling more stock, pushing the price down, causing other traders to also start to sell, causing the markets to go down.

Why would an increase in the VIX be different this time? As the first link tells us, some investors and analysts are arguing that a large spread between VIX futures and the current VIX price does not necessarily mean the market will pull back from current highs. They say, the increased activity in the VIX futures market is a positive sign for the economy. More investors are putting their funds into the market and as consequence, these investors must manage their risks by hedging against catastrophic market events (sudden Greek default, natural disasters, terrorist attacks, etc).

It is impossible to say what direction the market will head. Looking at the VIX is just one of many tools to help an investor decide how to invest their money. But my view is that the VIX only tells you something when it has already happened. Trying to read the tea leaves of the VIX futures market is bound to get you in trouble.