This complimentary article from Options Profits was originally published on May 29. Don't risk missing over 40 options trade ideas every week, educational content, exclusive commentary and webinars from over 15 experts. Click here for more information and a 14-Day Free Trial.
Looking at the stock market and ignoring bonds to determine the health of U.S. markets is a bit like buying a car based on looks alone. If the stock market is the U.S. exterior, the bond markets are the engine that really makes the markets work.
Take a look at this chart. If one were to quickly glance at it, they would think it was CBOE Volatility Index (VIX), since it peaks every time the market drops and craters at market highs.
It is not VIX, it is a 10-year weekly chart of iShares Barclays 20+ Yr Treas.Bond (TLT) through October 31 of last year, the TLT is the ETF that represents long term US debt (more than 20 years to expire). I illustrate this point to show how VIX and bonds are similar instruments. They are both what I would classify as insurance vehicles. The VIX represents that cost of insurance via S&P options, while the bonds are a safe haven investment for banks and funds.
If we zoom in from 2007-October 31 2011, you can see how similar they in movement. What the trader will notice is that typically the VIX moves sooner and in greater magnitude.
The TLT selling off typically signals that any major turmoil is ending. If a trader bought stocks when the TLT sells off from its peaks, rather than VIX, you would typically be buying pretty close to the bottom. This pattern persisted for the last 10 years. The two move so closely together that the difference of TLT-VIX almost always lands in the 70s, because when TLT is below 90, typically, the VIX is also below 20, and when TLT is above 120, the VIX is typically 40. There are rare occurrences on VIX pops where the spread falls below 70, and typically at the end of a financial crisis the spread threatens 80.