HARD HATS & THE VIX

Note: This article was originally posted 1-25-13, but deleted by human error.

Ever go to a construction site? Most of the workers, including visitors, usually wear hard hats. There must be a reason.

Indicators are as much a part of the markets as three pointers are a part of basketball or holding hands is in a new romantic relationship or volatility in life.

Investors love steady upside volatility of bull markets but deplore downside V in prolonged bear ones just as holding hands can be nice but as a long-ago popular song noted breaking up is sometimes hard to do. And costly.

VIX is a volatility index traders use to gauge the market's direction or if the market is over-bought or over-sold. It's based on a put-call options ratio. Options give one the right to do something. Options are what's known as decaying assets much like us, Homo sapiens; they too have a time limit.

Every year you buy a home owners insurance policy that has a starting and expiration date. Six months into the policy it's lost some of it cash-in value owing to time decay. That policy gives you downside protection if something nasty to your home happens, not a lot different from pre-nups if something gets nasty there.

 When you pay for that policy you just bought a put option, usually good for one year. If there's a big fire causing lots of damage, you're glad you bought the policy; if not you're out the premium but you had the feel-good feeling for one year knowing you we're covered. When fire happens you exercise your right to put or sell that policy back to insurance company and they pay for damages. You win this time. All others when no damages they win.

Put is play market headed down, call just the opposite. When things appear gloomy investors usually bid up the put prices and calls conversely get cheaper. It's the same the other way when the economic sun comes out and folks believe they can truly see for ever. Right now the VIX at 12.5, a 5 year low. Another way to say it is, it's an indicator of calmness or storminess....at 12.5 it's, to borrow a line from Coleridge's The Rhyme of the Ancient Mariner, "like a painted ship on a painted ocean." Things don't get much calmer than that.

If you're a sailor you need a bit of a wind to have a decent day at sea. Too calm or too windy, not so good. So VIX is a proxy on sentiment of a group of market players, sophisticated or otherwise.That's what it tells us. What it doesn't tell us is if they are correct. That's our decision, further proof there are no free lunches.

The late Julius Simon, an economist well-known in academia but much under appreciated in public eye, once noted we have Statue of Liberty on east coast and we should put a Statue of Responsibly on west coast. Simon was noted for his belief there are no such things as natural resources; the only one is the human mind without which any so-called natural resource--land, oil, bauxite,etc.--would remain inert, another way in our judgment of saying we have to decide and our decisions ain't free.

At one juncture in 2008 when it looked like the bottom was about to drop out of the ole economic container VIX traded in the 80s, an all- time high in its 21-year history. Its range over it existence is roughly 10 to 89 where it peaked in October 2008. Between 1990 and 2008 the VIX traded at an average just over 19. It's only traded below 14 about 1/5 of the time or 20 %. As noted today it's around 12.5, a 5-year low with largest move lower over the last 3-6 month period in 3 years. So are investors bullish or bearish? Well, one indicator that tracks such things shows about 53% bullish versus 23 % bearish the highest in 4 months.

Now that statistic about trading below 14 is important because in 6,000 days of trading VIX has only traded below 10 nine times. Remember that's 6,000 days of 4 or 5-day markets owing to holidays, etc. Last time it bounced below 14 was just before the current rally when market coughed up 7%. Seven percent from here is about 1,000 points and not a big deal, but 20% another thing.

The current market has discounted just about every piece of bad news that's come it's way, budget-economic cliff, higher taxes, Obamacare, global unrest, slow growth, inflation fears, the banshies at the Fed wildly printing money, you name it. So what's the blind side issue going to be? It's usually clear only in hindsight. So do we throw away our hard hats or keep them ready? You decide.