A VIX Event That Defies Reason

02/07/2012 10:10 am EST

Focus: OPTIONS

James Bittman

Senior Instructor, Chicago Board Options Exchange

News and fear-driven price swings have failed to produce the kind of action in the VIX that many would traditionally expect, says Jim Bittman, and it’s anyone’s guess as to why that is.

Europe is in the news a lot lately and it’s going to continue to be for a while here, but how is it affecting option trading and the VIX specifically? 

Our guest today is Jim Bittman to talk about that issue. So, Jim, how is all of the news in Europe affecting VIX and VIX traders?

Tim, I wish I had a simple answer to that question. In fact, I wish I had a coherent answer to that question. The fact is that when news comes out of Europe—good or bad—the Volatility Index (VIX) has been responding erratically. 

We had some good news in early-November 2011, and VIX did not go down. Then later, around the time of the Traders Expo in Las Vegas, we had some bad news about Greece and the market tanked, but VIX did not go up.  So, it’s really been an unusual time. 

For traders of VIX and VIX options, it’s been very very difficult. Portfolio protection strategies seem to be hanging in there, but the recent sharp moves in VIX that we’ve seen with other market hiccups have not been happening in October or November 2011, so the world continues to change and VIX continues to be a mystery.

See related: Using Options as Portfolio Insurance

So if it’s not Europe that is affecting the VIX, what do you think is the most important factor that the traders need to watch to see what is going to move it?

Well, VIX measures emotions, and when market emotions expressed through the buying or selling of options changes, then VIX rises or falls. 

If people are panicked and they will pay any price for an option to protect themselves or to cover a short position, then VIX skyrockets. 

If people are complacent and they’re selling options, confident that they’re going to get the premium, then VIX goes down.

So do you think that it means that people are discounting Europe? Are they so tired of hearing about it every day that they’re starting to be immune to it?

I think that’s as good a guess as any, and let’s face it, we’re all guessing at this point. But I think that’s as good a guess as any.

The people who’ve bought options to protect themselves have their positions in place and they don’t need to buy more, so there isn’t the emotional pressure to raise VIX.

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