What's going on?
Coronavirus-stricken global stocks dramatically dropped, jumped, dropped, and jumped again last week: in other words, “volatility” was high – its highest since the 2008 financial crisis (tweet this).
What does this mean?
The Volatility Index (VIX) – often referred to as the stock market’s “fear gauge” – shows the price investors are paying for options, which are a popular way to protect their stocks from losses. The VIX has ticked along at an average value of 18 over the last 15 years, but that number spiked to 72 on Thursday – close to the peak of 90 it reached during the 2008 crash.
Stocks tend to rise in slow waves and fall in rapid zigzags, which is why selloffs are often accompanied by volatility. And just as they might a stock or bond, traders can take advantage by buying and selling that volatility for a potential profit – which is why those who bought last month are now sitting on massive returns.
Why should I care?
For you personally: Gauge your own fear.
Buying the VIX is tricky. Fund managers use futures contracts to bet on the index’s direction, but retail investors don’t always have the privilege: brokers mightn’t let them invest in leveraged assets where losses can mount quickly. It’s simpler to buy into the VXX exchange-traded fund (ETF) instead. A word of caution, though: when the futures contracts the ETF invests in expire, it reinvests funds into new contracts that are typically more expensive than the VIX’s current value. This “rolling over” of futures makes the VXX an investment which loses value over time even if the VIX stays flat.
For markets: Uncharted waters?
The VIX’s closing level was the fourth-highest ever on Thursday. The index has never hit such an extreme without US stocks rebounding at least 10% over the next day or two, according to DataTrek Research. But if Friday’s initial bounce doesn’t carry on into Monday, “we are truly in uncharted waters”…