A little-known event in the CBOE Volatility Index (^VIX) may be flashing a warning sign that the market will see a big downside move this year.
To be sure, the VIX itself is a popular measure of expected volatility in the S&P 500 (^GSPC). Options and futures contracts against it vigorously trade hands every day.
And since the start of the year, the VIX has been elevated, something that happens when the market is worried. For most of 2016, it has been trading mostly above 20. That’s well above times of complacency, such as the period from mid-2012 to mid-2015, when the index was often found in a range between 11 and 20. The VIX’s counter-market tendencies lead some to call it the “Fear Index.”
Yet the VIX’s level in the spot market may not be the only indication of volatility in the months ahead, according to Russell Rhoads, director of education at the CBOE’s Options Institute.
His analysis shows that the term structure of the index’s traded futures contracts also gives clues about volatility in the upcoming year.
Recently, longer-dated VIX futures were trading at prices lower than near-dated contracts. This type of market is referred to as “backwardation” and happens often in some commodities markets. But that’s not usually the case with the VIX. Its futures usually see “contango,” where longer-dated contracts trade a premium to nearer-dated ones.
The index’s latest backwardation stint, ending on February 16, lasted 30 days. That’s the fourth-longest backwardation period on record for the VIX.
Based on Rhoads’ data, the S&P 500 sees a big move after the VIX goes back to contango from backwardation.
“Almost 90% of the time, the market has moved over 20% over the next year,” he said. “That’s 20% higher or lower.”
Source: Russell Rhoads, CBOE
“We’re probably going to have a pretty volatile 2016,” Rhoads added.
The second piece of the puzzle, found in the options market, may signal the direction of that move. Sadly for bulls, it could be to the downside.
Rhoads notes that options traders have been buying twice as many upside bets compared to downside protection on the VIX this year. This positioning shows the market is biased toward a higher VIX, which comes when there’s a view that the stock market will drop.
“That signals that the people that use hedging tools, which are the more sophisticated portfolio managers, are still pretty concerned about the direction of the market this year,” said Rhoads.
More from Yahoo Finance
- Personal Investing Ideas & Strategies