People associate falling markets with a rising VIX and as a pure correlation, VXX rising. Not only is the rising VIX not perfectly correlated with a falling market, but the VIX rising is not a pure correlation to a rising VXX. This is where it pays to know how all of these indices and exchange traded products are constructed.
The VIX is heavily weighted toward the December S&P index options, and after tomorrow, it will roll into January as the next-term option structure. The VIX does this one week before index option expiration, so as to avoid unusual OPEX fluctuations. Next week, the VIF, or the VIX far month representing the January options, will have a negative weighting in the VIX. I.E. the VIX will weight December at 1.25 and January at -.25.
VIX near and next month volatility: (VIN becomes VIF on Friday's close)
December has very low seasonal volatility tendencies. So next week, and essentially today in fact with one day to roll the index options for VIX calculation, the VIX is overweight December volatility. December and January options price in a lot of time decay due to the holiday season market closures, as well as seasonal equity trends during the holiday season.
No matter how you view the fiscal cliff, or the long-standing ineptitude of government leaders, the markets will do what they do. And it's telling you something during this sell-off. The options market is not expressing high anxiety relative to the degree of selling that we've witnessed since September, and intensifying this week. Part of this is due to seasonal factors, but part of it is also probably due to historic low interest rates, monetary policy, and decent U.S. economic fundamentals. Where else can you go to get a return above 1%? There are plenty of stocks with yields much higher than that while generating solid cash flow fundamentals.
The VIX futures fell today, therefore the VXX fell. The VXX should have fallen more, as it's indicative value (the value of it's holdings, not it's trading value) fell even more than the trading price. This happens occasionally, but it is generally resolved quickly, as it is easily arbed out. Long futures and short VXX is that trade. See the indicative value here:
|VX X2-CF||S&P 500 VOLATILITY||November2012||16:15:00||18.50||-0.35||18.50||18.90||18.06|
|VX Z2-CF||S&P 500 VOLATILITY||December2012||16:15:00||19.25||-0.25||19.20||19.60||18.80|
|VX F3-CF||S&P 500 VOLATILITY||January2013||16:15:00||20.55||0.00||20.45||20.80||20.08|
|VX G3-CF||S&P 500 VOLATILITY||February2013||16:14:59||21.20||0.05||21.00||21.45||20.70|
|VX H3-CF||S&P 500 VOLATILITY||March2013||16:14:59||21.80||0.10||21.60||22.05||21.34|
|VX J3-CF||S&P 500 VOLATILITY||April2013||16:14:59||22.50||0.05||22.50||22.75||22.10|
|VX K3-CF||S&P 500 VOLATILITY||May2013||16:15:00||23.15||0.05||23.15||23.35||22.70|
|VX M3-CF||S&P 500 VOLATILITY||June2013||16:10:56||23.65||0.10||23.30||23.79||23.20|
|VX N3-CF||S&P 500 VOLATILITY||July2013||16:02:49||24.39||0.24||23.90||24.39||23.90|
So the negative roll is now 4%, and you can see why the exchange traded products on the VIX were not up today. What can change this? If the market sells off significantly below the 200 sma, then the VIX could rise significantly. But at this point, we have seen a 6.6% correction over 37 days, the 4th longest correction since May of 2009. It is also the 4th deepest correction in two years.
So, until the VIX crosses above 20, there is not a lot of downside fear in the options market.
Additional disclosure: I am long Dec VXX puts