Market Volatility And The Fed: What Are People Thinking?

| June 17, 2013 | 0 Comments

Fed Chairman Ben BernankeUntil recently, 2013 has been a relatively low volatility year for the stock market.  For instance, for much of the first five months of the year, the S&P 500 Volatility Index (VIX) was sitting in the $12-$13 range.

As the market’s most prominent investor fear gauge, the VIX was showing very little investor concern for much of this year.  It’s no surprise with volatility so low, several major stock indices hit all-time highs.

However, June has been a different story so far.

Stocks have been choppy – and the moves seem to be gaining magnitude as we go.  The VIX has been as high as $18.60 this month and, more importantly, hasn’t been below $15 or so.

While the VIX isn’t high on a historical level, it’s certainly sitting at a substantial increase over what’s been prevailing for most of this year.  So what gives?  Why the big increase in volatility?

Basically, it’s all about the Fed.

Well, it’s really about central banks across the world.  But many of the world’s most prominent banks will be influenced by decisions made by Bernanke and friends.

Here’s the thing…

The markets are being roiled by concerns over when monetary stimulus may end (or be tapered back).  Investors like bond buying programs and low interest rates.  These factors inspire confidence and inflate asset values (which is the goal).

So, in places like the US and Japan, the threat of stimulus reduction is causing serious investor heartburn.  Already, we’re seeing some movement from stocks to safer asset classes.

The funny thing is, the whole scenario is pretty ridiculous.

The main impact of monetary stimulus is psychological.  Central banks want consumers to have enough confidence in the markets/economy to spend money instead of stashing it all away. 

The idea is to get people to spend until the economy recovers enough to where spending is more “natural”.  At that point, the Fed can taper and cut the stimulus because artificial confidence is no longer necessary.

And therein lies the comedy…

The only reason the Fed would cut bond purchases right now is precisely because the economy is getting better.  Last time I checked, that’s exactly what investors should want.  (Japan is a different story, but the Bank of Japan still may take some of its cues from the Fed.)

So basically, the Fed has stated it won’t cut bond buying unless the economy is showing significant signs of growth.  And, the impact of monetary stimulus is almost entirely psychological to begin with.  So why are we seeing a spike in volatility and investor concern?

As usual, investors tend to be irrational at times.  It’s really hard to know why stock buyers would lose confidence in this scenario.  But, that’s what makes the stock market so unpredictable.

However, unpredictability can also be a boon for options traders.

One way to play this added volatility is to simply buy VIX calls.  After all, volatility is still low by historical standards.  On the other hand, if you believe the stock market is still in good shape, you could buy index calls on the bigger dips.

In this environment, I think either strategy could pay off.  Keep in mind, periods of investor irrationality are often the best times for savvy traders to make money.

Yours in Profit,

Gordon Lewis

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Category: Breaking News

About the Author ()

Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also editor of our dynamic theme-based options trading service, Advanced Options Adviser, and one of the key analysts behind the highly successful Options Trading Wire.