It seems that volatility is being mispriced.

I say this because the Volatility Index (VIX) closed Tuesday at 16. That’s near its lowest level for 2021. It’s down about 35% from where it was trading just one month ago.

That makes sense… sort of.

After all, the S&P 500 closed at its highest level ever on Tuesday. And, the VIX usually falls as the stock market rallies.

But, it also doesn’t make sense. We are in the midst of earnings season – when volatility tends to increase. We’re also heading into a Federal Open Market Committee (FOMC) announcement next week.

And, this announcement could be HUGE…

You see, FOMC representatives have been teasing about beginning a tapering process as early as November. They’re not talking about raising interest rates… the Fed is still a long way away from doing that.

But, the Fed has been talking about reducing the amount of bonds it purchases every month.

If that happens, then it’ll be the first step towards stopping the quantitative easing (QE) program since the Fed started it back in 2008 (QE is the introduction of new money into the money supply by a central bank). That’ll be the first major change in Fed policy in 13 years.

It’s hard to imagine a scenario where that doesn’t affect the stock market. Yet, the VIX is trading near its low of the year.

That seems odd to me…

Of course, we don’t know for sure what the Fed is going to do or say when it makes its policy announcement next Wednesday. But, there is the possibility – and to me it seems like a very real possibility – of a major policy shift.

And, the market doesn’t seem to be discounting that yet.

Volatility is cheap right now. It’s as cheap as it has been all year. I expect it’ll become more expensive as we head into next week’s FOMC announcement.

Traders will probably do well betting on a higher VIX between now and then.

Best regards and good trading,

Jeff Clark
Editor, Market Minute