The CBOE Volatility Index (VIX) has moved sharply lower thus far in 2010.
How low can the VIX go? Well, using history as a guide, we may be nearing important reversal points around the 17.5 and/or 15 level.
As a quick primer, among its other purposes the VIX actually measures what option implied volatilities on the S&P 500 Index (SPX) are projecting the 12 month return will be (based on 30 days worth of option pricing). This means that with the VIX at 18.4 currently, market makers are pricing that the SPX could be 18.4% higher or lower 12 months from now.
Take a look at a 20-year monthly chart of the VIX below (click to enlarge). You can see that there have been clear multi-year ranges. 1991 to 1997 saw the VIX largely contained between 10 and 20. 1997 to 2003 saw an expansion in volatility with a new bottom of around 15, and a new upside of around 40 (although the majority of the range was contained between 17.5 and 30. 2003 to 2007 saw us resume the lower 10 to 20 range. 2007 to 2010 has seen us resume the 17.5 bottom area, with upside exploding past 40/45 to as high as just below 90.
VIX Monthly Chart
Based on these previous patterns, we could look to 17.5, and below that 15, as the new bottom of the range. Especially considering the recent massive parabolic move we saw in volatility, I would not anticipate that we would fall back into the 10/20 range of more calm times. So keep a close eye peeled with the VIX testing 17.5 this week ... ultimately we certainly could go as low as 15, but in this area would be a likely area to reverse higher sometime this year (or even next year). On the upside, we would be likely to test 30, and beyond that 40/45. Moving above 40/45 has looked to be the statistical breaking point, beyond that is "panic upside".
Could the VIX break below 15, and subsequently test 10 or even lower? Certainly this is possible ... for example, if we establish a long-term trading range "dead quiet" market, volatility could drop to unprecedented lows. However, given the recent earthquake shocks in the chart, this does not appear imminently likely. With worldwide government debt, real estate fallout, emerging market bubbles, political instability, currency troubles, commodity bubbles, interest rate risks and other potential storms on the horizon, one would not expect that things will remain quiet or even peaceful for too long.
Knowing your history from long-term charts will allow you to see the "Big Trends" as they are emerging and are important to keep in mind in your shorter-term momentum and swing trading.
Disclosure: No positions.
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