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Is VIX at the New Bottom or the New Top?

|Includes: iPath S&P 500 VIX Short-Term Futures ETN (VXX)

Traders are making much of yesterday’s drop of the volatility index (VIX) under 30% for the first time since the Lehman bankruptcy in September. Please see my April 7 forecast that it would collapse from 40%.  Are we now at the bottom of a 30%-50% range, or will 32% be the new ceiling on the way back down to the 10% we saw two years ago? Part of the confusion springs from a misunderstanding of what the VIX is by ordinary investors. It is just a mathematical guess about how big the next move in the market will be.  A 40% VIX implies that one out of three days will see a 2.25% palpitation, and once a month we will suffer a 4.5% gyration. You can have the market drop 10%, rise 11.1%, remaining unchanged, but still generate a tremendously high VIX. The equation doesn’t care what the direction is. VIX unfairly picked up a bearish connotation because of the panicked rush by long side only investors to buy downside protection in falling markets, driving “put” implied volatilities through the roof. This is why investors associate a high VIX with falling markets. In the end, this debate can only be resolved in one way, and that is to the downside. Smart hedge funds that shorted out of the money calls on VIX higher up, are now taking profits. But the VIX will crash again when markets go to sleep, as they inevitably will. Believe me, trading around a low VIX is your worst nightmare. Traders don’t pull down million dollar compensation packages playing “Solitaire” on their computers.