Summary Volatility is a powerful tool that allows to profit from market sentiment. Seasonality data suggests volatility is set for more downside. U.S. economic data will take a center stage for the remainder of the year, but unexpected developments overseas may bring about more volatility. The oldest and strongest emotion of mankind is fear, and the oldest and strongest kind of fear is fear of the unknown. H. P. Lovecraft The wounds are still fresh. The last couple of months were tragic for global capital markets. It was all about the turmoil in equities, caused by global economic uncertainty, slowdown in China, and the Fed’s indecisiveness to raise interest rates due to inflationary and employment concerns. This has pushed the U.S. and global capital markets into correction territory, the second worldwide decline in less than a year. The markets bottomed on August 23rd, and reversed in ironic fashion, climbing back up to the pre-correction levels of mid-August. As of November 3rd, the U.S. major indices were mostly flat for the year. Following the action in the equity markets, CBOE’s Volatility index , or VIX, advanced rapidly, as investors rushed out of their positions. The Volatility Index (VIX), often referred to as the gauge of fear, has gained 140% over the course of one week, following the dovish announcement from the Federal Reserve to keep interest rates unchanged at the FOMC meeting on August 19. VIX, of course, has a negative correlation with the S&P 500 index, which lost close to 10% during the same period of time. (click to enlarge) As markets reversed their trend, so did the VIX. It declined steeply to the lows of early August, to indicate the rising confidence of market participants. Investors who have not watched the markets closely during that period of time might have spared themselves some sleepless nights. For some people however, the global turmoil and rising uncertainty in the stock market had equally presented an incredible opportunity to profit, by investing around wild swings in volatility. With the correction behind us, I’d like to give my projection for the VIX, as we now entered the last two months of the trading season. Short-term volatility outlook. Following the recovery in equity markets, volatility has declined more than 70% from it’s peak on August 23rd. While that is undoubtedly a significant move to the downside, I believe that the VIX has yet to hit its bottom. Below are several factors that are set to weight heavily on VIX performance going forward. Seasonality It is no secret that the behavior of certain investment instruments differ throughout the year or from one stage to another within the economic cycle. Constantly recurring seasonal events fundamentally affect the performance of individual stocks, indices, and overall markets. Many traders look out for these patterns on the chart to determine the momentum of the instrument in question. Volatility is one of those affected by the seasonality. (click to enlarge) If history holds any clue, both November and December comprise the period of declining volatility, that generally peaks in October, as per chart above, which indicates the average annual performance of the VIX over the last 20 year period, ending 12/31/2014. Interestingly enough, the Volatility Index behaved astonishingly similar in 2015. And although certain skepticism still prevails in the market, it is unlikely we see another correction any time soon, that might propel volatility higher. In fact, investors should now feel more confident, after tackling a pullback in equities, believed by many to be overdue. Specificities . December is certainly the month to watch, as both year-end portfolio rebalances and more surprises from the Fed may cause investors to become uncertain. The U.S. economic data will take center stage during the last two months of the year, as non-farm payrolls for October and November will be dissected for clues in regards to the timing of the initial rate hike. As futures indicated a 50% chance of December rate hike as of November 3rd, I predict any negative number to add volatility to the market. The first GDP estimate for the third quarter was driving U.S. markets this past Thursday. Nevertheless, this figure will be subjected to further revisions in November and December, and will not cause much volatility, as market participants have already priced in the increase of only 1.5% for the quarter. More stimulus from China and Japan, as well as positive remarks from ECB’s Mario Draghi on situation in Europe, will definitely propel markets higher. China, on the other hand, still poises the biggest threat for global capital markets stability. An additional slew of worse-than-expected data from Beijing will likely trigger GDP downgrades, that will re-ignite the fear of global slowdown. Lastly, expect the end of the year trading activity to be light. The holiday season is likely to keep investors on the sidelines until the new year sets in. This does not necessarily mean a quiet period for the markets. Investors should follow the news closely, as illiquid exchanges are less likely to absorb selling pressure caused by global developments. The ways to use volatility to your advantage Every investor who would like to trade around market sentiment might want to consider gaining an exposure to the CBOE’s Volatility Index (VIX). Although it’s impossible to purchase VIX directly, there are ways to gain such exposure either through options, or by taking a position in one of the designated ETFs. Volatility as an investment vehicle has unquestionably gained in popularity among investors. Almost every ETF provider now issues products that are linked to the volatility of a broader market. These products vary substantially in terms of leverage, liquidity, and underlying assets, but they all try to replicate either a long or short position in the Volatility Index. VIX currently trades at $14, which implies roughly 15% downside, if traded against its long term support. One of the ways to speculate on that is by shorting the Barclays S&P 500 VIX Short Term Futures ETF (NYSEARCA: VXX ), that re-invests in volatility futures on a rolling basis. From my observations, VXX incorporates 30% to 70% movement of the VIX during short periods, suggesting 5% to 15% move to the downside, excluding contango drag down. For investors who might want to gain a leveraged exposure to the VIX, the VelocityShares Daily 2x VIX Short Term ETN (NASDAQ: TVIX ) would be the second best instrument to short. It currently trades for $5.85, or more than 15% above it’s pre-correction levels. In addition to that, the current state of contango is expected to weigh heavily on volatility ETFs if shorted for an extended period of time, suggesting even more downside. Risk-reward, however, is not as attractive as it was a month ago. After falling significantly from its peak, volatility still preserves enough momentum to justify an ongoing decline. However, investors now face far greater risk associated with the strategy, and should be aware of any potential loss related to it. Despite my bearish volatility outlook, I generally seek better risk-reward potential to initiate a position. Preserving the money in this case is far greater concern. Nevertheless, any small speculative bet at this point is definitely warranted. I urge market participants to be more cautious when putting money to work at this time of the year. Best of luck to all investors!