Is Stock Market Volatility Too Low or Too High?

Goldilocks and the Three Bears is a 19^th-century English fairy tale that captures children’s attention. In the story, Goldilocks tries three bowls of porridge. One is too hot, another is too cold, and the third is just right. In psychology, the Goldilocks principle is the cognitive effect that people confronted with similar choices tend to gravitate to a more moderate option.

The VIX index is the stock market’s volatility barometer, measuring the implied volatility of put and call options on S&P 500 stocks. The VIX tends to rise when stock prices fall and fall when they increase. Since options are price insurance, the demand for insurance often increases when stock market corrections occur. Conversely, market participants tend to grant or sell options during quiet periods or rising share prices to increase income via option premiums.

Many market participants follow the VIX as a fear barometer; when it rises, it signals increasing odds of a market correction. A declining VIX indicates greed as it implies higher share prices. In August 2023, the Goldilocks VIX principle at the 16 level is telling us there is not too much fear or greed in the market and share prices are “just right.”

The VIX range over the past years

• In 2023, the VIX has traded between 12.73 and 30.81.
• In 2022, the range was 18.95 to 38.93.
• In 2021, the VIX reached a 14.10 low and 37.51 high.
• In 2020, the low was 11.75, and the high was 85.47.
• The 2023 range was inside the 2022 band.

Markets reflect the economic and geopolitical landscapes

• Economic data moves stock prices higher and lower.
• Geopolitical events can impact the stock market.
• Central bank monetary policies, elections, war, and other events directly impact the path of least resistance of the stock market.

A rising base for the VIX

• In 2017, the VIX reached an 8.56 low.
• The VIX has not traded below the 10 level since 2017.
• A rising base level points to the acceptance of periodic corrections, increasing the demand for price insurance.

The unknown causes the most fear

• The VIX’s 2020 85.47 high occurred as the global pandemic surprised and shocked market participants.
• The 2022 38.93 peak resulted from Russia’s invasion of Ukraine.
• Surprises tend to push the VIX to extremes.

The VIX is just right today- Tomorrow could be another story

• VIX levels above 30 are too high and tend to decline.
• Since 2021, VIX levels under 15 are too low and tend to increase.
• At the 16 level on August 25, 2023, the VIX could be just right for the current economic and geopolitical environment.
• Any surprises over the coming days, weeks, and months will likely cause upside spikes.
• While the Goldilocks principle tells us the VIX is just right at 16, the downside is limited, and the upside could be explosive.