The S&P 500 has closed at new all-time highs for six consecutive months. And yet, the Cboe Volatility Index (VIX) refuses to go quietly.
Despite this relentless strength in stocks, the VIX remains above 16 – a level that doesn’t exactly scream “complacency.”
That’s notable, because the VIX is widely known as the market’s “Fear Gauge.”
Formally, the VIX measures the market’s expectation for annualized volatility in the S&P 500 over the next 30 days, derived from options prices.
But for traders and investors like us, its real value is much more practical: it tells us how much movement the market is pricing in on a day-to-day basis.
The Rule of 16
Here’s the quick, back-of-the-napkin way to think about the VIX.
Take the VIX level and divide it by 16. That gives you the expected daily move the options market is pricing in for the S&P 500.
So…
- a VIX of 16 implies about a 1% daily move;
- a VIX of 32 implies roughly a 2% daily move; and
- a VIX of 50 implies a daily move north of 3%.
The math behind the “Rule of 16” can get deep into the weeds, and you don’t need to master it for this to be useful. If you’re curious, it’s worth looking up and doing the homework.
At a high level, it comes from how volatility is annualized and the fact that there are roughly 252 trading days in a year. The square root of 252 is just under 16, hence the shortcut.
I’ve been doing this since 2003, and I’ll be the first to admit I don’t pretend to fully understand all the options math. Most people who claim they do… don’t.
Markets give you a choice: keep things simple, or overcomplicate them.
This is one of those times where simple works just fine.
Keep It Simple
I know Everybody’s Wrong attracts a lot of smart, curious readers. I see it every day, and I love that.
But here’s the truth about making money in markets: You don’t need to be the smartest person in the room. You just need to be slightly less stupid than everyone else.
That means keeping the math simple:
Addition. Subtraction. Multiplication. Division.
That’s plenty.
If you really want to go deeper into how options and volatility work, Sheldon Natenberg’s “Option Volatility & Pricing” is widely considered the gold standard. If you’re going to read one book on the subject, that’s probably it.
But it’s not required. I haven’t read it – and I read a lot – and I trade options all the time.
Today isn’t about mastering options theory. It’s about using a simple, practical tool.
Take the VIX. Divide it by 16.
That’s the daily move the market is pricing in for the S&P 500.
What VIX > 16 Means
So despite the S&P 500 sitting near all-time highs – and closing at record levels every single month for the past six months – the market is still pricing in big daily moves.
Remember, the VIX nearly kissed 30 last month. And the month before that. Falling “down” to 16 doesn’t suddenly make volatility disappear.
Complicated math or not, a VIX at these levels is still relatively elevated. And that tells me to continue expecting larger-than-average swings.
There’s also plenty of room left on the downside for volatility itself. The VIX doesn’t need to stop at 16. It can fall to 12. It can fall to 11. It can even revisit single digits.
I’m not saying it has to, but let’s not pretend it can’t. I think it can. And I think it will.
And if volatility has another four to six points of downside ahead of it, ask yourself what that likely means for stocks.
To me, that points to more upside in the S&P 500.
Until then, a VIX north of 16 means the market is still pricing in 1% daily moves. So don’t be surprised by the swings.
They’re smaller than they were at the peak last month, but they’re still large, especially considering how strong stocks have been.
This is not a sleepy market.
Stay alert. Respect the volatility.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs