The VIX: Could the “Fear Gauge” Call a Market Bottom?

Since the Dow started its precipitous drop from its record high of 14,000 one year ago, options traders and savvy investors have been waiting for the S&P Volatility Index, or VIX, to take notice. The VIX is often referred to as the fear index, but no matter what happened — the popping of the housing bubble, the collapse of Bear Stearns, the implosion of the monoline insurers — it stubbornly refused to trade above 35, a remarkable sign of complacency (the VIX traded as high as 150 in 1987). Even the government takeover of Fannie Mae and Freddie Mac failed to move the needle.

That all changed on September 17, when Lehman Brothers came under intense pressure leading up to its bankruptcy filing and the VIX took up home in the 30s. And when Congress failed to pass a bailout bill after the close on September 26, the market collapsed and the VIX spiked to 46.72. Today, it trades in the 50s. (See Chart) Now, it appears investor complacency has gone the way of Lehman.

But contrarians everywhere see the rise in fear as a possible buying opportunity. The Dow has dropped 5,000 points, they say, and though the market may still drop another 1,000 points or more the VIX is one sign confirming that we may be oversold. Of course, the problem with being oversold as that you can always get more oversold, but Barry Ritholtz of Ritholtz Capital Partners believes the VIX is signaling a trading low, if not a permanent one. “It doesn’t mean you run out and go crazy but this is not the time to panic,” Ritholtz says. “The time to panic was a year ago.”