What Is The VIX Saying?

The CBOE Volatility Index is a measure of the fear in the market. The VIX measures, in percents, the 30-day annualized return in stocks within one standard deviation.

So, if the VIX is at 15, it means that the S&P 500 is expected to gain or lose 4.33 percent over the next 30-days with about 68 percent probability.

Recent Spike During Market Sell-Off

The measure of volatility in stocks usually rises alongside market sell-offs as investors tend to sell quickly and buy slowly. Thus, the recent spike in the VIX, from a low of 11.05 to the current 19.04, implies that the market sees increased volatility in stocks. At the low, the market was expecting a mere 3.2 percent move in stocks but now expects a move of nearly 5.5 percent.

Also to note is the velocity at which the VIX tends to rise followed by the much smaller rate at which the index declines. Looking back to 2008 during the financial crisis, the VIX rose to nearly 80 from below 20 in less than a month. Then, it took the VIX over a year to drop back below 20. Overlaying the VIX on the S&P 500, it can be seen that sharp drops in the S&P 500 coincide with large spikes in the VIX while the slow decreases in the VIX coincide with the "grinds" higher in stocks.

The current spike in the VIX has seen a near doubling in market expectations of volatility and fear. Thus, the move may be done. The VIX has already begun to retreat from recent highs and could be signaling that the recent sell-off has been overdone and that stocks are at least due for a correction.

Strong Call Buying

Chatter of strong buying of 1,600 call options in the S&P 500 Monday morning means that investors were betting on a bounce off of this morning's low in the current future of 1,553.25. Also, the futures held technical support at 1,552 and have further support slightly below. Thus, the move lower may at least be due for a breather.

Now, the strong call buying could also just be a sign of traders looking to pick up quick profit on a correction in stocks. And sure enough, S&P 500 futures have rallied nearly 15 points off of the lows after the early morning plunge and are fast approaching the closing level from Friday.

Should the VIX hold at current levels, it would most likely mark a bottom in stocks. After all, not much has fundamentally changed in the economy except for the Federal Reserve warning that it may stop buying bonds at a record pace in the near future; and recent Chinese fears may actually be overdone because the smart money has been raising fears over China and emerging markets as a whole for a while now.

What to Look For

A stabilization of the VIX and a slow, orderly decline in the index would be a sign that the market has found a bottom. Also, relaxed bearish comments on the global economy and statements from the Fed that tapering may not be so bad will all be signs that a correction in stocks may be ending.

If this is the case, materials stocks that were hammered, especially on Monday, could see a nice bounce back on some short covering. Also, watch housing stocks if rates begin to decline after the massive move higher in interest rates in late May and so far in June. Lower rates would be a bullish sign for housing stocks and signal relaxed fears about the Fed and tapering.