Large options trades can provide clues to make market moves, notes Jay Soloff....
Don't Get Hung Up on the VIX
04/02/2009 12:00 pm EST
Bernie Schaeffer, editor of the Option Advisor and chairman and CEO of Schaeffer’s Investment Research, says investors should look beyond the VIX to track the market.
Much is made of the VIX as a “fear gauge”: A rising VIX is alleged to indicate heightened investor fear and a depressed VIX investor complacency.
The fact that the VIX is a calculation of the implied volatilities of a set of Standard & Poor’s 500 options, and that these real-world option volatilities are very much determined with reference to recent realized market volatility, is considered a footnote at best.
But we all know that the VIX peak near 90 in October was not matched at the November lows when it peaked at around 80. But S&P 500 historical volatility peaked in November at about 20 points below its October level. [So,] the failure by the VIX to take out its October peak on the lower market lows in November can be explained—not by some mysterious “fear deficit” among investors at these lower lows, but by the fact that the realized volatility of the market fell short of October’s levels.
But of greatest interest of all is [that even though] the market took out its November lows by a large margin earlier this month, the VIX peak on this pullback was at a meager 53, which was in a different zip code from its October and November peaks.
But this moribund VIX peak was perfectly consistent with S&P historical volatility—which has yet to exceed 50% so far this year—and one could argue that “investor complacency” had little to do with the refusal of the VIX this year to match its 2008 peaks. In fact, not only did historical volatility react little to market weakness; it also did not decline on the historic rally off the March bottom.
The bottom line is that realized market volatility has flat-lined in 2009 at the low end of its range for the past six months, despite all the gyrations in the market. And this has turned on its head the maxim that declining markets are accompanied by higher volatility (and elevated investor fear) and that rising markets are characterized by a decline in volatility.
So, what does the catatonia in market volatility—albeit at elevated levels—imply (if anything) about market direction? A break by the VIX below the support at 40 that has stubbornly held in recent weeks could be an indicator of capitulation by the bears that could stoke another market surge.
Another level to watch is the declining 80-day moving average of the S&P—currently at about 830—which has contained all rallies since mid-2008. A clear break above the 80-day would represent a significant change of behavior for this market and be indicative of further up side. But another failure at the 80-day level would be very ominous and would argue for a retest of the March lows.Subscribe to the Option Advisor here…
Related Articles on OPTIONS
A straddle is a trade that engages both at-the-money put and call options, notes Robb Ross....
Paul Cretien describes opportunities in the grain complex through pairs trades....
Jay Soloff provides a trade for those expecting a sharp increase in volatility in March. See him liv...