The announcement on Oct. 10 that the debt ceiling limit may again be raised sent the stock market (IWM) up close to 2% as the S&P 500 (RSP) regained much of the ground it had lost earlier in the week.
It also sent the volatility indices like the VIX back down to the mid-teens, approaching their historically low ranges.
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Is this the end of volatility for the 4th quarter?
A History Lesson
The table below is one I created of the S&P 500's VIX Index and shows since 1990 the average monthly VIX (CHICAGOOPTIONS:^VIX) price, monthly maximum price, and monthly standard deviation.
Highlighted in shades of red, the first, second, and third most volatile months based on each respective average VIX price, maximum VIX price, and largest VIX standard deviations are identified.
The final three months are actually the most volatile of the entire year while the least volatile are the summer months.
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Again looking at the table, the first standard deviation of the VIX's price for each of the twelve months ranges between $5 and $12, October and November are the only two that reach the double digits. This means that volatility of the VIX in October and November is the highest of any of the other months. December is a close third, also producing well above average volatility.
Noteworthy as well and highlighted in yellow is the average VIX price in October and November. At over $22 versus an average closer to $20 over all the months, this shows that the monthly volatility is typically skewed toward the upside instead of the downside during these two months and also shows that October and November have historically had the most "fear" by market participants.
The most recent VIX rally of the past two weeks didn't even send volatility to its normal October reading of $23.30, barely even reaching into the $20s.
History suggests that the volatility of the past few weeks may just be starting as the 4Q kicks off.
Ways to Take Advantage
The VIX table above was first provided to ETFguide.com readers on 9/26 in an article I wrote entitled, "Calm Q4 Ahead for Stocks?" when the VIX was trading around $14 and it was suggested to buy the VIX for an expected pickup in volatility.
In the short period since then, the VIX popped to over $20 as volatility heated up.
Ahead of this, we alerted our subscribers in our October ETF Profit Strategies Newsletter released 9/20/13 as well as numerous times in our twice weekly Technical Forecast, by writing:
"As we've consistently noted, the S&P 500 has been making new highs, yet the VIX hasn't bottomed. This is a rather large discrepancy and the previous times stocks have made new highs without the VIX hitting new lows, it warned of a short term market top. We're buying the Dec 2013 VIX Call Options at $540".
We alerted subscribers on 10/8 in an intraday alert to harvest some of their quick profits when those contracts rose almost 50%, to $790. The remaining portion still sits with admirable profits as we watch the market's (SSO) next moves as it flirts with the very important 1682 level.
Is that it for the 4Q VIX?
These VIX opportunities are nothing new to us at ETFguide.
Numerous times this year we have watched the market making new highs, but the VIX not making new lows. In technical terms this is called "positive divergence" and it shows a market rally that is likely suspect. Typically, market volatility drops as stocks rise, and conversely, volatility rises as stocks fall.
When this sequence of events does not occur, it can help in warning that the market's upside (or downside) is likely limited. Numerous times this year, the VIX has provided warnings signs. This occurred in February. It occurred again in April. It also occurred at the May highs, all of which offered great opportunities to buy the VIX and ride it into the upper teens for quick profits.
September's new price highs also saw a similar divergence helping us jump on the VIX opportunity again. With the statistically volatile October and November now here, VIX calls will again likely offer numerous opportunities over the next few months.
Other ways to play a 4th quarter rise in the VIX for aggressive traders is to buy the riskier exchange traded products such as the iPath S&P 500 VIX short-term (VXX) or the levered ProShares Ultra VIX (UVXY), making sure to take satisfactory profits whenever they occur because of the increased risks in using these instruments.
VIX call options remain a great choice for portfolio protection for longer term hedgers based on history alone, but they and the VIX exchange traded products also will likely offer more aggressive traders a few opportunities between now and the end of the year.
The ETF Profit Strategy Newsletter follows the VIX and other tradable asset classes looking for high probability profit opportunities. The statistical evidence of a more volatile next few months coupled with an already increased risk of uncertainty out of Washington means traders should be ready to protect their portfolios from increased downside risk.
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