Tuesday, July 17, 2007

Premature Demise?

I always like it when someone who writes about investments for a living goes out on a limb with a bold prediction, unhedged, about the future of the markets.

The CXO Advisory Group has made a hobby of keeping track of how well gurus forecast the future of the markets and has concluded that as a group, the success of guru predictions averages a little worse than a coin flip.

For better or for worse, these statistics have not deterred Rob Schumacher of Van Kampen Investments from predicting that the VIX “may become as relevant as yesterday’s news. Schumacher cites the elimination of the short selling “uptick rule” (Rule 10a-1 of the Securities and Exchange Act of 1934) as the culprit and argues that unencumbered short selling will lead to increased short sales and a corresponding decrease in demand for puts.

While no doubt some future put activity will manifest itself as short sales, the key question is one of scale, which quickly calls up issues of leverage, liquidity and transaction costs. My best guess is that the end of the uptick rule will have a negligible impact on put volume, as short sellers continue to favor the highly leveraged bets on baskets of large stocks that puts make possible. I also suspect that most market players ultimately believe blanket portfolio insurance is cheaper and more effective than point insurance – and the weaving together of a constantly moving thousand point quilt.

Finally, new legislation notwithstanding, it is always dangerous to bet against the popularity of any instrument that is setting new volume records, as VIX options did less than a week ago, just a couple of days after the uptick rule was eliminated.

If Schumacher is correct, then I can retire this blog and devote more time to becoming a better trader. If he’s wrong, I sure hope he has hedged his position with puts…

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