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VIX hits 5-year high

The widely followed Volatility Index hit a 5-year high today as you can see in the graph above. The VIX is also known as the fear index, and the higher it goes the more likely you’ll see a very volatile market, yet ultimately higher stock market prices as weak investors are forced to sell at bargain prices to committed long-term investors.

Analyst Donald Luskin writes: “Peaks in the VIX are closely associated with market bottoms. That’s because climaxes of fear are times when everyone who’s ever going to sell has sold — and when all the sellers are out of the way, the buyers have the field all to themselves. Take a look at the peaks in the VIX — the crash of October 1987, the oil crisis before the Gulf War in 1990, the global financial crises of October 1997 and October 1998, and the panic following the terrorist attacks of September 2001. They were all terrific buying opportunities. And now we’ve got another one. On average since 1986 (when the VIX was first calculated), the market has returned 16.9% in the 12 months following VIX readings above 40 — that’s more than half-again better than the 11.3% average for all 12-month periods.

“What’s the VIX exactly? It’s a measure of the market volatility reflected in prices of Standard & Poor’s 100 index options traded on the Chicago Board Options Exchange. To understand the VIX, all you have to do is grasp what volatility means, and then see why volatility gets reflected in options prices.

“Volatility is just a statistical term to measure the tendency of the market to fluctuate — a lot or a little. Big fluctuations like we’ve had recently suggest fear, because they mean that investors are frantically changing their minds about what stocks are worth in the face of great uncertainty. Smaller fluctuations suggest that investors are confident that they know what stocks are worth.”

Donald Luskin wrote this back in 2002, the last time that the VIX was above current levels. Then, it was at 40 at the peak of the post 9-11 market correction. Since then, stocks have performed amazingly.

There is no reason to think that today isn’t a buying opportunity just as it was in 2002 and earlier this year when the market sold off. Long-term investors with the conviction of their belief in their investment strategy will see profits from trades made at this level.

More later!