Traders Confident Santa Claus Coming To Town

Shorter-term stock volatility expectations have dropped to their lowest levels in more than 4 years.

We’ve covered the term structure of stock volatility indices on several occasions. This, again, refers to the relationship between the various durations, e.g., 8-day, 1-month, 3-month, represented by these indices. The concept is that when nearer volatility indices trade at a historically high extreme versus indices further out, it can signal too much fear on the part of traders and set the stage for a potential rally. Conversely, when near-term volatility expectations become extremely depressed relative to longer-term, it can signal too much complaency and the potential for weakness in the stock market. That latter condition may be present now.

As recently as late July, we mentioned the relationship between the 1-month volatility index (VIX) and the 3-month (VXV). At the time, the VIX/VXV ratio had dropped to .76 for just the 4th unique time ever. We hinted that it may be a red flag for stocks as they had historically struggled in the short to intermediate-term after similar low ratio readings. The VIX/VXV would remain depressed for much of the next month, leading to a moderate pullback into the election.

Well, following the post-election rally, complacency is back. Today, the VIX/VXV ratio closed at  .7469, the 4th lowest reading ever and the lowest since August 2012. Here is the updated chart from the July post showing historically low readings since the inception of the VXV in 2007.

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