Is the Low VIX a Warning for Stocks?

Published: Wednesday, 23 Dec 2009 | 11:33 AM ET
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By: Patti Domm
CNBC Executive Editor

The VIX hovers near its low for the year, and the stock market trades near its highs.

Traders on the floor of the New York Stock Exchange.
Photo: Oliver Quillia for CNBC.com
Traders on the floor of the New York Stock Exchange.
On the surface, those kinds of moves may make you feel good about the stock market rally. The low VIX — a sign of low volatility — may even make you feel a little bit complacent.

But some traders watch this type of scenario as a possible warning sign.

There is, of course, the old Wall Street saying: "VIX low. Time to go."

Dan Deming, who trades the VIX, says that sometimes a low VIX and a high stock market precedes a stock market sell off. He says this may not be the case just now, but just so you know, the last time he told me this was right before Thanksgiving. Who can forget the day after Thanksgiving when the S&P 500 lost 1.7 percent!

"It kind of indicates the market's at extremes. If it's going to new highs with the VIX staying a little bit off the lows or kind of in a holding pattern, it bodes better for the market," he said. "The VIX has been under pressure for the past month or two so the market is getting in a better position to support these high levels."

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The Chicago Board Options Exchange's volatility index is watched as a measure of investor fear or uncertainty. Low volatility also goes hand in hand with low stock market volume. The VIX was trading higher Wednesday. It fell below 20 Tuesday for the first time since August, 2008 and it is now about 75 percent below the peak it reached during the height of the financial crisis.

Deming said the current move may not be the set up for a fall but he's watching it nonetheless. He also mentioned another recent trend that has recurred for the past several months. As the month drew to an end, the VIX traded lower, but leading into the new month, it would see a spike.

"The market is setting up for a year end rally, and with volatility going to a new low for the year, people are saying that's a good sign for the new year," he said.

Deming said the focus in the pits now is on the S&P 500 and whether it will close above 1121, a level technicians are watching. "If we break through there, we'll probably see a nice pop," he said. That could set up a further decline in the VIX , which might be when the low VIX really does signal "time to go."