In Declining (Low) Volatility = Rising (High) Complacency I concluded that right when investors are the most complacent, the trend changes. Prices fall, volatility spikes up. They feel more sure about things after prices have been rising, so there is less indecision reflected in the range of daily trading. When investors feel more uncertain, they become indecisive, so the range of prices spread out. That is why I believe a VIX at low levels it is now is evidence of complacency. Complacency means a person feels smug about how things are going.
In What does the VIX really represent? I explained another reason we may consider it a measure of fear or complacency. The VIX measures the cost of insurance. When there is more buying than selling in the option market, the market is buying protection, which is an indication of fear. In fact, options are most often overpriced – their implied volatility is higher than realized volatility. Option prices often reflect the premium paid for protection because of the fear of volatility or falling prices. When the VIX is low, as it is now, the cost of insurance is low and that tells us there isn’t a lot of protection buying (fear). They don’t believe volatility will be too high in the next 30 days. Of course, it’s often when people don’t expect a thing to happen that a surprise comes along.
But one indicator by itself isn’t necessarily enough to proclaim that all market participants are complacent. The VIX measures how short-term options are priced, and most investors don’t trade options, so we could say it’s mostly options traders sentiment, although there are all kinds of options traders. However, it does tend to correspond with other sentiment indicators.
If you hear someone say that VIX below 11 isn’t a big deal and isn’t a sign of complacency, well, you may consider what that means. I just said it means people are complacent, so it shouldn’t surprise you if they are. The more doubt we hear the more it confirms the belief. And, maybe they are selling vol hoping it will stay low and keep falling.