The volatility to come – measuring market uncertainty

The US S&P 500 is arguably the most influential share market index in the world. Trends in the S&P 500 (.SPX) affect global sentiment. This means that the outlook for the SPX is important to every investor around the globe, not just investors in the USA. As the US election approaches, analysis points to a rise in uncertainty, and potential disruption for stock markets.

The chart below shows the VIX, or Volatility Index. Also referred to as the Fear and Greed index, it is a quick guide to current market sentiment. In broad terms the VIX rises as the share market falls, and drops as stocks rise. The VIX rises with investor concerns and falls on investor confidence.

At the bottom of the chart is the historical volatility of the volatility index. In the period before the August drop in the SPX and spike in the VIX, the volatility of volatility fluctuated in a range between 60 and 120. In October trading the SPX has resumed its rise and set new records. As expected, the VIX fell. However the vol of vol has not returned to the base levels around 60. Instead, vol of vol appears to have found a new, higher base level closer to 100.

For traders the prospect of higher volatility represents increased opportunity, albeit at higher risk.

How investors interpret and respond to this market factor depends on their circumstances. However the elevated level of vol of vol strongly suggests investors examine, and if necessary adjust, their risk management. Whether that means trimming portfolios, diversifying, hedging using options or ETFs, or simply holding tight and preparing to ride out any market disruption, is up to the individual.