The VIX, also known as the “fear indicator” in a measure of the amount of people buying downside protection options (Puts) on the S&P 500. When the market is getting clobbered (like now), this index will reflect increased Put buying by rising in price. What’s odd is that if we take a quick look at a the VIX chart we can see that it has barely budged. Rising from a low of 14 to just 16 even as the S&P 500 has dropped about 8%.
Yet, between April and June of 29012 as the S&P 500 dropped about 10% the VIX rose from 14 to 28. So what gives?
Why are investors expressing less fear now than they did back in April?
There are two potential reasons that we need to look at. The first is that the Street believes that the so-called fiscal cliff will not come to pass in all its fury and that the politicians will be able to come to an agreement that spares us the very worst of what the fiscal cliff promises. That’s a big bet, but in my opinion it’s a correct one.
The second reason is that this sell off could just be about investors and traders locking in their gains ahead of the fiscal cliff. Remember, long-term capital gains taxes are set to increase from 15% to 23.8% (for affluent investors) in 2013. What we could be witnessing is investors locking in their gins at a 15% tax rate with an eye to buy back in.
If that scenario is accurate then that would explain why the VIX has barely budged. After all why would you buy downside protection if the reason that you sold wasn’t a lack of faith in the market but it was more about dodging a higher tax rate? It makes sense that you would not see elevated put buying in the S&P 500.
Short of inside information or some type of mystical second sight we’ll never know for sure until after the fact. Even the very best of technical indicators are little more than handicapping mechanisms that give us the ability to determine how likely it is an event will take place, they are not crystal balls.
So far the indicators that we use at ETFWarrior.com suggest that this sell off is a buying opportunity in an on-going uptrend. So there are two ways to play this. One of you are a long-term investor and another is you are a short-term trader.
Long term investors can buy the S&P 500 index right here as it sits below its 200 day moving average. The easiest way to do so would be to buy the ETF SPY. This ETF will give you direct exposure to every gyration the S&P 500 experiences.
Could the S&P 500 go lower, sure it could! But if you are a long-term buyer, dollar cost averaging into the S&P 500 on pullbacks below the 200 day moving average will have you stacking up a systematic series of great long term entry points into this index.
Short-term traders can do the same thing but they’d want to use a stop loss on the trade at $126.
The other index to take a look at is the NASDAQ 100, the QQQ. Both long-term investors and short-term traders can buy the index right here at $62 and change. Once again this one has plunged below its 200 day moving average and represents a buying opportunity.
Long-term investors can use pullbacks below the 200-day moving average as a dollar-cost-averaging opportunity and short term traders can view this as an oversold-bounce trade. Short-term traders would use a stop loss of $58.
One sector to avoid like the plague right now though is semiconductors. The semis have been beat up and they look cheap but I just think they have some more downside in them to go. SOXX is the iShares Semiconductor Index and it’s been massacred lower from $60 to $48.46. I’d love to buy it…. but just not yet. If $48 fails to hold this one could tumble lower to $44-$45.