Using the VIX To Determine When The Next Market Crash Will Occur

Some studies have shown that market crashes are extremely unlikely to occur when the VIX is below 15 or above 50, but that they are likely to occur when the VIX is between 15 to 30; and, though this prescient gauge is driven by investors’ fears (which subject it to the potential of false positives)  it is certainly one worth watching.

VIX Chart Pattern As Of 7/22/2013

StockCharts.com

Presently, the VIX is situated at 12.54 which, if the studies are correct, would indicate that no market crashes are lurking on the horizon. I must say, however, that I find the low VIX reading a bit curious given the current state of affairs with our economy. Nonetheless, it would certainly seem that investors’ fears are low and that we have nothing to fear — or do we? The other side of this equation is the fact that, when investors seem to have nothing to fear, it would mean that investors are also very complacent; and, as many of us know, that is the time when the rest of us have the most to fear.

For those who wish to learn more about the formula that is used to calculate the number of VIX Call Options that one must purchase to protect a given portfolio, the CBOE has published a great article which includes the formula. A PDF version of that article can be downloaded here.

As with a life insurance policy, one should not wait until the onset of a crisis to seek-out portfolio protection. Know your options (pun intended) and watch for changes in investor sentiment by watching VIX price movement trends.

NoteCharting data provided courtesy of StockCharts.com.

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