Volatility Upon Volatility
Leave it to Wall Street to create derivatives of derivatives.
Think back to the great financial crisis in 2008, for example…
Remember how Lehman Bros. collapsed and nearly took the entire financial system down with it?
The cause: derivatives, specifically something called collateralized mortgage obligations (CMOs), which Wall Street created, and it nearly killed them.
As Warren Buffett famously said derivatives are “financial weapons of mass destruction,” but I digress. The point is there are plenty of reasons folk are fearful of the markets.
Enter the VIX
Wall Street created the CBOE Volatility Index (VIX) years ago to measure stock market volatility. It has come to be more commonly known as the “fear gauge” for stocks.
Of course, Wall Street wasn’t happy with just that. The Street also created a derivative of VIX known as the VVIX. The VVIX is an indicator that measures the expected volatility of the VIX — in other words, the volatility of volatility!
You just can’t make this stuff up.
As you can see above, the VIX is on the rise right now, making a series of higher lows.
When that’s happened in the past, it’s often followed by a much bigger explosion in stock market volatility, as you can also see above.
Also, recently the VIX and VVIX, which typically move together under “normal” market conditions, have started going their separate ways, as you can see in the chart above.
Forewarned Is Forearmed
In the past when the VIX has started rising from very low levels AND the VVIX has diverged from VIX, bad things happened to stock prices as market volatility spiked much higher.
If this plays out again, perhaps triggered by a potential trade deal with China falling through or some other calamity, you can bet a stock market correction will surely follow.
No need to panic, however.
Later in the week we’ll cover some of the best ways to protect your wealth if this scenario begins to pan out.