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Lions and Tigers and Bears, Oh My!

Fear gauges turn red. Then…

The past week was scary. And it wasn’t just Halloween goblins that spooked folks. Outright fear pervaded the markets as Election Day drew nearer (and as its outcome became more uncertain). There wasn’t a good place to hide, either.

The so-called “fear index,” the CBOE S&P Volatility Index (VIX), started ratcheting up in a serious way on October 28 and the hit the 20 percent red zone on Friday amid a protracted stock price swoon. That fear spilled over into other markets as well. The CBOE Gold Volatility Index (GVZ) and the CBOE/CBOT 10-Year Treasury Volatility Index (TYVIX) promptly joined VIX to trade at levels well above their 10-day moving averages.

Volatility spikes are typically short-lived and are often seen as opportunities for swing traders. In this case, that would mean buyers trying to catch reactive bounces in stock prices and short sellers hoping to profit from slippage in the cost of gold.

 

Volatility indices are derived from option prices, but fear was reflected by other markers. If you compared the 20-day returns earned by the SPDR S&P 500 Trust (NYSE Arca: SPY) versus those garnered by the iShares 20+ Year Treasury Bond (NYSE Arca: TLT), you’d have seen evidence of the fright flight from equities as the weekend approached.

 

Stock traders often look to non-correlated assets like gold to hedge equity market volatility. Nowadays, that’s made easy for individual investors. Retail-sized all-in-one transactions can be effected by purchasing shares of the REX Gold Hedged S&P 500 ETF (NYSE Arca: GHS), a portfolio that emulates equal-weighted exposures to the S&P 500 and gold futures. During the Holloween harum-scare 'em leading up to the election, GHS shares held up while SPY tumbled.

 

Then, on Sunday afternoon, swing traders got their wish, perhaps a little earlier than even they anticipated. Investor sentiment shifted dramatically toward relief after U.S. presidential candidate Hillary Clinton was once again cleared from prosecution by FBI director James Comey. Over night, stock futures rallied and gold prices tanked. By the time the dust settled on Monday night, the S&P 500 had rallied 2 percent while COMEX futures slid by a similar amount.

Going forward? With the election behind us, fear will likely stabilize at baseline levels—that is, until the next crisis of confidence emerges. For VIX, the baseline’s been a reading of 16 percent this year. For GVZ, the average has been about 18 percent. Savvy investors will keep an eye peeled for excursions above these levels to gird themselves for reactive turns. Reading the fear gauges is the first step in navigating around—and exploiting—market tumults.

 

Brad Zigler is WealthManagement.com's Alternative Investments Editor. Previously, he was the head of Marketing, Research and Education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds.

 

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