US stocks could see big swings to the downside this week on any remotely “bad” news since volatility indexes are at levels considered too low.
Investors also will face a blizzard of earnings, which many analysts believe will continue to support the rally that began early this month. But any disappointments in either earnings or outlooks could, of course, trigger a sharp sell-off.
What’s more, the market is likely to continue to garner support from investors’ hopes that the Federal Reserve will take more steps to stimulate the economy, in what is known as “quantitative easing” or “QE2”. The Fed is expected to unveil its initial commitment under QE2 at its 2-3 November meeting.
The Chicago Board of Options Exchange (CBOE) Volatility Index, or VIX – used to measure investors’ anxiety levels – fell 2.54 per cent on Friday to close at 18.78, its lowest level since April. The VIX, which rose to near 50 in May, has been around or under 20 for the past two weeks.
Options traders note that there is a clear sign of extreme complacency in the VIX and that it is making the market more vulnerable than before.
“The ‘market volatility’ index will see a lot more volatility (this week) since it is at such low levels now,” said Steve Claussen, of OptionHouse.com.
The iPath S&P 500 VIX Short Term Futures exchange-traded note, or ETN, is also at a new 52-week low of 12.83. The ETN offers directional exposure to volatility and is based on the front two-month VIX futures.
“If you look at VIX futures, investors seem to be always preparing for something to trigger the volatility to spike up again, yet there is nothing major in the immediate future that justifies that,” Claussen said.
The VIX futures were traded at around 21 for November and 24 for December, but going into 2011, they were showing an increase of 40 percent, trading above 26.