Monday, November 10, 2008

VIX-ology

So alot has been said about the VIX and where its going lately. To review, the VIX is a statistic that reads 30 day ATM implied volatility in the SPX, or a general market barometer of fear. The higher the VIX goes, the more traders are willing to pay for put options on the SPX. Its pointless to guess what is a buy in the market based on the VIX and what is not. Before last month everybody thought 35-40 was an absolute panic state and was a good sign of a market bottom. Well that did work for the early part of the year but in the past month things have changed and changed big time. We have entered a new period of higher volatility and I think it is here for a while.

Anyway, interesting article out of Schaeffer's on Monday talking about the discount to Historical volatility that the VIX is trading at lately. In other words HV, or volatility of the SPX index itself, is much higher than IV in SPX options and therefore the VIX is trading at a discount to the SPX historical vol even at these lofty levels. The reason this is important is because before a bullish advance in the markets you would want to see the VIX trading at a significant "premium" to historical volatility, and it is not. As the chart to the left shows, during much of this volatility since Sept. the HV of the SPX itself actually traded higher than the actual VIX. This happens only very rarely and is sometimes troublesome as Joe Sunderman, Vice President of Financial Market Analytics, goes on to say:

It is difficult to draw a quantitative conclusion when there are so few historical references to draw upon. I do feel that this discount in the spread is a troublesome development. I remain concerned with the complacency I am seeing among option players. Bulls would want to see the VIX trading at a steep premium to SPX volatility, as a sign that fear is rampant among the investing community.


He makes an interesting case that perhaps we might have not seen the height of fear just yet. Either that or volatility is a screaming sell up here still in the 60s! Lol, but because of the fact that we have just been drifting lower in the VIX and not really seeing any meaningful collapse tells me that he could be on to something and we might just have to watch these markets for a little more turbulence. I mean you can make a case for both sides of the map here but being aware is the best way to make a decision so I will leave it at that and say keep watching that VIX; and be sure to check out Adam's site at Daily Options Report as I think he has some of the best thoughts out there on the VIX, and is a daily read imo.

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