Thursday, August 30, 2007

Echo Volatility, Day 10

Following the 2/27 VIX spike, I had a lot to say about echo volatility in this space.

My dog explains the concept best, but a good working definition of echo volatility is along the lines of “the tendency for markets to be more susceptible to volatility spikes in the wake of an initial volatility spike.” Some historical context is available at “VIX Spikes and Echo Volatility” and I looked back at post-2/27 echo volatility in “Lessons from the Post-2/27 VIX Price Action.”

Finally, in response to a reader question, I presented an important element of my thinking regarding echo volatility in “When Is Echo Volatility Safely Behind Us? Here I offered two key takeaways:

  1. The first ten days tell you very little about future VIX prices that you don’t already know by just applying ‘normal’ VIX mean reversion tools to the close on the day of the spike. By day 15, it is possible to predict future VIX price levels [30-60 trading days out] with considerably more accuracy and by day 20 I would say that I am ‘as comfortable as possible’ about making predictions about future VIX levels and the possibility of more echo volatility.

  2. One of the golden rules of VIX mean reversion is that if mean reversion does not play out over the course of 10-20 days, then we are likely headed for a period of extended volatility.

So, here we are on the tenth trading day after the August 16th 37.50 VIX spike top, with a very small echo volatility bounce that took the VIX from 20.44 to as high 26.67 in two days, still almost 30% below the VIX spike top. It is too early to discount the possibility of an another echo volatility VIX spike in the next week or two, but by the end of next week and particularly by the end of the 20 day window on September 14th, the window of opportunity should be closed and we should be able to put the 37.50 spike and any subsequent volatility spikes to bed.

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