Monday, June 30, 2008

Don Fishback on Complacency in the VIX/VXO During Selloffs

When someone follows the VXO more closely than the VIX, it is usually because they have been doing it for a decade or more and found no reason to switch when the CBOE changed how the VIX was calculated back in 2003. For all practical purposes, the differences between the VIX and the VXO are not meaningful enough for most investors to warrant monitoring both volatility indices.

With that preamble out of the way, I am pleased to report on some interesting research on the VXO by Don Fishback, who is indeed an experienced hand when it comes to options and volatility. Looking at instances going back to 1986 in which the OEX (the S&P 100 index, which is the underlying for the VXO) declined 10% and the VXO remained under 30, Fishback concludes:

“Bottom line is that when the market falls 10% off of a recent high, and VXO stays below 30%, what was bad gets worse. In every prior instance where VXO failed to climb to above 30%, the market continued lower. The MINIMUM additional downside is another 10%.”

Granted, these conclusions cover only six data points that fit the statistical profile noted above, but the correlation between the level of the VXO when the 10% OEX decline is met and the extent of the subsequent decline over all 14 data points in the study is also worth pondering. Read the full article at 10% Declines and VXO Less than 30% and consider checking out another take on Don’s work by my blogging alter ego at Daily Options Report.

When it comes to VIX spikes a signs of a market bottom, my thinking is remains that while we don’t need a Brunhilde Day to signal capitulation, the higher the VIX spike, the higher the odds that a bottom will hold. See January’s Can the Markets Bottom Without a VIX Spike? for a more detailed discussion of VIX spikes and market bottoms.

4 comments:

Marc said...

So how do you explain the VXN? It's not too far from the peak set at the March lows. I think the Dow is getting skewed by the financials and commodities whereas the Nas is more tied to growth companies and as such is more reflective of the economy.

When everyone starts saying the same thing, the market changes course to offset the herd.

Marc

transformation said...

mon 12:58 PST, 3:58 pm ESt:
boy, talk about end of day distribution! more bearish, but not unduly so. dk

Bill Luby said...

Some interesting points.

If you look at a chart going back say 4 months, the VIX and VXN have tracked almost identically up until last Mon/Tue, when the NAS got whacked by itself.

At the moment, the VXN has retraced about 60% of the post-March spike, while the VIX has retraced less than 50% -- and I attribute most of the differential to last Monday and Tuesday.

Frankly, I didn't expect that LEH could fall below 20 and not significantly spook the markets.

The short week will make for some interesting action as the skittish longs look to exit and/or protect themselves.

My hunch is that the Thu employment report will be worth at least 200 DJIA points in one direction or the other. Of course, I'm not sure about the direction...

Cheers,

-Bill

Marc said...

Bill,

As of the end of today the VXN has retraced 75% from the spike in March to the low in mid-May. The VIX has retraced 46% over that period.

What does this mean? Well for starters, the Nasdaq is holding up better than the Dow on a relative basis. The interesting thing is that the Nasdaq usually drops more than the Dow during declines yet that's not happening. It's leading me to believe that the bearishness is more concentrated in blue chips (somewhat of a misnomer these days, eh?).

VIX not withstanding, there sure is a lot of bearishness out there just looking at the news.

Cheers,
Marc

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