A slide in the ‘VIX’ shows stock market jitters have ebbed

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A closely watched gauge of investors’ fear level about the stock market has fallen to its lowest level of 2008. But is that a good omen or a bad one?

The so-called Volatility Index, or VIX, is a measure of investors’ expectations of near-term volatility in the market. It’s calculated based on activity in Standard & Poor’s 500 stock index put and call option contracts. Investors and traders use options either to bet on market swings or to hedge against them.

Trying to understand how it’s put together will give you a headache, but suffice to say many Wall Street pros keep a close eye on the VIX. And since the credit crunch deepened last summer the index has been a great contrarian indicator, at least for short-term traders: Each time it spiked above 30 –- meaning investors’ fear had reached intense levels –- it foreshadowed that the market sell-off of that moment was cresting, and that a rally (however fleeting) was imminent.

Meanwhile, low points for the VIX since July have signaled near-term market peaks (i.e., good times to sell).

So is this a better time to sell than buy? The VIX, at 19.59 on Friday, was at its lowest since Dec. 26. But if investors’ worries about the market continue to ebb, the index could go a lot lower –- meaning, what looks low now might not be so low, after all.

Sam Stovall, chief investment strategist at S&P in New York, notes that a steadily declining VIX from 2003 through 2006 coincided with a rising stock market.

The index is a long way from its recent multiyear low point, which was 9.89 on Jan. 24, 2007. That low signaled that investors expected little volatility ahead in the market. As it turned out, many investors had been lulled into a sense of complacency they would come to regret: February 2007 brought some of the first signs that the sub-prime mortgage mess was a looming disaster for Wall Street and the economy.

Posted April 28, 2008