How the Smart Money Is Positioning Itself Now

The macro story: The major indexes were very quiet today, as the Dow Jones Industrial Average (INDEX: ^DJI) and the broader S&P 500 (INDEX: ^GSPC) finished up 0.15% and 0.22%, respectively. Unusually, however, for a day on which the indexes produced a small positive return, the VIX (INDEX: ^VIX) gained 5% to close at $18.42. The VIX,“ nicknamed the "fear index," is a measure of the market's expectations for short-term volatility in the S&P 500.

Typically, increases in the VIX are associated with stock market declines. Today's rise is consistent with a report from Barron's, according to which savvy investors, including macro hedge funds, have been buying up call options on the VIX that expire at the end of the month, with strike prices of $20 and $22.

While I have no particular talent at cartomancy, I can observe that the VIX is not expensive by historical standards, even after having risen nearly 40% off its August low. Tomorrow's election will not eliminate policy uncertainty --€“ the fiscal cliff associated with automatic tax increases and spending cuts is looming large. For professional investors, betting on an increase in volatility looks like a decent bet.

On a fundamental note: Standard & Poor's released its latest earnings data for the S&P 500. As we near the end of earnings season, we're heading for a 2.5% year-on-year decline in third-quarter earnings. Full-year estimates for 2012 and 2013 continue to drop. On the latest data and based on today's closing price, the S&P 500 is valued at 12.5 times next year's estimated earnings per share. That certainly looks cheap on the face of it, but one can't rule out further declines in earnings estimates.

Some smart investors may be buying VIX options, but another set is following a contrarian strategy that is open to all investors. Click here to find out which are The Stocks Only the Smartest Investors Are Buying.

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Alex Dumortier, CFA, has no positions in the stocks mentioned above; you can follow him on Twitter, @longrunreturns. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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