Risk, Insurance, and Horses

Financial markets go up and down, and sometimes a bit more than on other days. That’s called volatility and the VIX index measures how much the S&P 500 will fluctuate in the next 30 days. In buying the VIX, investors can protect themselves against a fall in stock prices and much can be gleaned from how much they are willing to pay for this type of insurance.

At the moment, the VIX is trading at 24, which implies that stocks will move by 1.5% per day. That’s comfortably below panic mode which starts at 30, but worryingly up a long way from 15 when all is good in the world. That probably sums up the state of the world as well as anything. There has been a flurry of activity lately, much of it unprecedented, some of it incomprehensible, but most of it also not entirely irreversible.

If you are the one selling insurance to investors, the risk is firmly skewed against you. You can buy the VIX at 24 and lose a lot if it goes back to 15. However, if you sell, then you will lose a lot more if it goes to 100, as it did in 2020. Therefore, the index tends to trade at a premium when investors are most worried. In other words, the best time to buy insurance is when the markets are calm, not after the horses have already bolted.