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How Investors Can Take Advantage of Falling Volatility

Thursday, April 29, 2021 03:49 PM | Neal Farmer

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How Investors Can Take Advantage of Falling Volatility

Market volatility has been a major focus for investors since the pandemic first struck just over a year ago. There had been some spikes in volatility in early and late 2018 but early March 2020 saw markets at their most volatile since the financial crisis. The Chicago Board Option Exchange’s CBOE Volatility Index (VIX) spiked from roughly 13 to nearly 70 in under a month. The VIX steadily declined afterwards but remained above 20 until March of this year and traded above $37 as recently as January.

Current Market Volatility

Since the new year volatility has been sliding consistently with the VIX right around $18 currently and was low as $16 just a couple weeks ago. Additionally, there has not been a massive spike in volatility since late January when the Reddit-fueled GameStop (GME) drama was just beginning and some traders were worried it may crash the market. After all that craziness, traders have been enjoying an increasingly stable market with the S&P 500 up more than 13% already in 2021. The main question for investors is how long this may continue and how to maximize profits from a more stable market.

Why Is Volatility Down?

It’s not particularly shocking that there is less fear in markets now than back in March 2020 when the severity of COVID-19 was completely unknown and market participants did not know how lethal or contagious it was. Society has a much greater understanding of the virus now and vaccines are being distributed at high rates while economies continue to reopen after maintaining various levels of quarantine measures for much of the last year to slow the spread. The reality is that the global economy is in a much better place now than it was a year ago and while some countries continue to struggle with the coronavirus, many are administering vaccinations at a high rate and are seeing their economies recover.

Even if the recovery pace has slowed recently and the economy is not where it was pre-pandemic, investors are more confident about where the market is heading as the worst of COVID-19 looks to be behind us. In many states, vaccinations are readily available to anyone over the age of 16, and retail stores are reopening their doors and allowing for higher capacity inside their buildings. As daily vaccination numbers have risen volatility  in markets was falling with a exception of a brief period in early March when vaccine doses fell and volatility rose following the severe snow storms that brought much of Texas to a screeching halt. This can even be seen as vaccine doses per day have been falling over the past two weeks and volatility has been creeping upwards again albeit at a very slow rate.

How To Profit

The simple answer for profiting in a more stable market with lower volatility is the boring one as well. Buy and hold.

Lower volatility means less price fluctuations for the majority of stocks but that also means more confidence in markets and should lead to steady consistent returns. It’s hardly a coincidence that as vaccine doses have risen and volatility has slid, that the S&P 500 and other major indices have just been chugging along. While the S&P 500 is up more than 13% so far this year, the Dow Jones Industrial Average is also 12% higher and the tech-heavy NASDAQ has gained more than 10%. Lower volatility might mean less chance for significant gains but it also means much lower risk and higher confidence in markets. Blue chip stocks and index funds will give consistent returns over the long haul.

"YOLO" and Reddit traders might not enjoy the more steady market compared to late January when GameStop, AMC Entertainment Holdings (AMC), and other meme stocks were surging, but this also provides an opportunity to transition from YOLO trader to investor. For those who want to continue making riskier bets or hedging positions, lower volatility also means lower call premiums on option contracts. Long calls tend to be more expensive when volatility is high and cheap when it is low. With major indices all up big this year and at all time highs, call premiums are far cheaper for investors currently. This then gives investors a low-cost opportunity for more bullish bets on the market and/or a cheap way to hedge a short position.

In general, lower volatility markets are good for the average investor who wants to buy and hold and take part in market gains over time. Shorter term investors who want to place riskier bets in hopes of large gains can still find those trading opportunities, they just might not be as common, especially in higher market-cap stocks.

Wrapping Up

Volatility is trending downward as we move toward putting the pandemic behind us.  More than 140 million people in the United States have received at least one dose of the COVID-19 vaccine and recent comments from the Federal Reserve and White House suggest continued aggressive support for the economy. For the time being that is good for the average investor. Anything can happen in the future that might shock markets and lead to a spike in volatility. However, for now, investors should be looking to take advantage of an increasingly stable market and hopefully have already realized some of the gains markets have achieved since the New Year.

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