Monday, April 6, 2009

Today’s Jump in the VIX

Lately it seems like I am the only one who is not talking about the VIX. I find it particularly ironic that many of the same people who were pounding the table saying that the market could not bottom unless there was another dramatic VIX spike and high volume capitulation are now insisting that the markets cannot rally from current levels until the VIX continues down. I suspect these pundits will end up going 0 for 2 in their predictions.

For the record, at the very moment the SPX formed the “devil’s bottom” of 666.79 on March 6th, the VIX was at 51.65, which was not even the high for the particular day. By the end of the day, the VIX was down to 49.33 in what looks in retrospect like a classic stealth bottom.

So what is driving the VIX right now? In a previous post, I opined that a simplistic conceptual model of the VIX is one which “incorporates incremental changes in uncertainty and fear on top of recent historical volatility.” Many of the common measures of historical volatility (10, 20, 30 and 50 day) show that historical volatility in the SPX topped in the middle to latter portion of March. Since the 7.08% jump in the SPX on March 23rd, trading has been relatively subdued from a volatility perspective. As that 7.08% jump as well as the 6.37% and 4.07% jumps from March 10th and March 12th begin to scroll off the lookback window, historical volatility numbers should begin to lead the VIX back down.

As far as fear and uncertainty are concerned, the fear of a global systemic bank failure seems to be receding, while concerns about a deepening global recession are lingering and still rising in some quarters. The G-20 meeting underscored the willingness of leaders of the world’s largest economies to coordinate their activities, even if they cannot agree on the details of those coordinated efforts.

Finally, we are in a news cycle lull this week, but earnings season officially kicks off with Alcoa (AA) reporting tomorrow.

The bottom line is that current levels of the VIX are in line with historical volatility readings and changes in the macroeconomic landscape. The fear component of the VIX is clearly on the wane, which should mute any VIX spikes. On the other hand, historical volatility needs to continue to decline and the VIX term structure (which is based on SPX options) and VIX futures need to soften somewhat before the VIX can reasonably be expected to start trading in the 30s on a regular basis.

Many analysts have a tendency to rely too heavily on charts when looking at the future of the VIX. While charts can provide some useful information and it is nice to know that the VIX has recently moved below its 200 day moving average, sometimes putting the VIX in the proper geopolitical and macroeconomic context is a more valuable approach.

So…I think the VIX is about where it should be right now and stocks can resume their move up without the VIX being required to plummet. In fact, if the bulls continue to keep the upper hand, expect the VIX to decline in a decidedly gradual fashion.

Finally, the VIX jumped 3.1% today, while the SPX lost 0.83%. That -4x move is typical of the VIX, but not on Mondays, when ‘calendar reversion’ usually means the VIX jumps about 1.5%. Add to this the 1.53% that the VIX fell during the 4:00 – 4:15 p.m. ET index trading portion of Friday’s session and one could make the argument that the VIX barely moved at all today relative to the SPX.

For another perspective on the recent movements of the VIX, I recommend More Ways to Look at Volatility from Daily Options Report.

38 comments:

Frank said...
This comment has been removed by the author.
Anonymous said...

The VIX is going to collapse? Huh? No, the VIX is going to stay in a range of 35-50 for the foreseeable future. As long as the govt. continues on the zombie bank path, and ignores the housing market and foreclosures you can expect high market volatility. Look at the COT on the big S&P500 for the past few weeks. A VIX collapse is not on the horizon.

Frank said...
This comment has been removed by the author.
Douglas said...

Bill

Thanks for this, it has provoked a question in my mind.

Do you think that if trying to isolate fear and complacency in the VIX I should adjust the VIX for historical volatility?

If so, how do you suggest that could be attempted?

Douglas

Douglas said...

Bill
You said the following in your post:

'The fear component of the VIX is clearly on the wane, which should mute any VIX spikes.'

Do you mean (i) that fear itself is declining or (ii) the extent to which fear itself is affecting the VIX is declining - i.e. for a given level of fear, the extent that it affects the VIX is on the wane?

...if you can see the distinction in my mind.

Thanks

Douglas.

Jeff Pietsch CFA said...

Najarian called for a ten point haircut on the VIX on the uptick rule reinstatement... I could have heard that wrong... but seems a "stretch" of the imagination anyhow. Thoughts? Jeff

Anonymous said...

Najarian's scenario is entirely plausible. According to my analysis of VIX options, VIX will end up well below 40 by the May expiration of VIX options. For the next several months it's also the same. But this doesn't mean the stock market will soar, though, as the hedge funds have figured out a way to make the market drop without increasing the VIX too much. Witness the "mini-crash" we had from early Feb. to early Mar. where the market dropped 20% but the VIX stayed subdued.

Sethdominus said...

didnt we do this like 2 months ago
on february 15th or so
where you were saying the lower vix
etc etc
well i said it before and we will do it again
i took some vix calls today on the obvious non confirmation of vix with move..that wont last long vix should spike imminently/imminently off the full moon reversal...truth be told

Anonymous said...

I agree with you the VIX should spike soon. My analysis confirms it. But afterwards it should gradually revert to its historical mean of 20 or so. Many options experts have called for this and they are NOT joking.

Charts and Coffee said...

I would be interested to hear your take on the VIX today. Market down big and the VIX goes down with it.

Anonymous said...

The formula for VIX (from CBOE's paper) assigns higher weights to options with lower strike prices, and since puts have lower strikes than calls (remember: VIX only considers out-of-the-money options), today's drop in VIX shows the increase in VIX from higher put prices (due to the market drop) can't offset the decrease in VIX from lower call prices. This means there was no panic buying of puts today and the increase in put prices was only due to the drop in the market.

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Steven Vincent said...

If you look at the VIX chart from a technical point of view, it broke down today from a continuation triangle and out of an extreme 50/200 DMA moving average squeeze. This almost always portends a large, rapid move. Have a look at the chart:

http://stockcharts.com/h-sc/ui?s=$VIX&p=D&st=2008-05-07&id=p15496906804&a=163637954&listNum=3

http://stockcharts.com/c-sc/sc?s=$VIX&p=D&st=2008-05-07&i=p15496906804&a=163637954&r=2247

Anonymous said...

Steven:

My approach is a little different from yours. While you analyze VIX's chart, mine is to analyze VIX options. From my analysis I think the VIX is likely to spike soon, which should coincide with an overall market drop, but afterwards it should gradually fall back to its historical mean of around 20.

From recent market behavior, it seems to me when the VIX spikes, the market would drop precipitously as there is significant put buying, but the reverse may not be true, i.e. when the market drops VIX may not always shoot up.

Also, I may not agree with you that because the market didn't break down today (4/8) a major short squeeze is on the way. The Good Friday is approaching, and the market may simply be making us feel good by not sinking too much. Also, I saw several commentators on the Web pointing to declining SPY volumes four days in a row, but that may be due to that many traders are on vacation this week so let’s not read too much into it.

Anonymous said...

Another reason you know stocks are likely to drop soon is that Jim Cramer is feverishly pitching stocks and encouraging retail investors to jump in. While Cramer’s advice is useful at times and he reveals the truth from time to time, he is the quintessential cheerleader for the Wall Street “Old Guard” and his advice is pretty accurate contrarian advice. If you go read his articles on RealMoney.com these days, the reasons he says stocks will keep rising almost border on laughable. And it’s obvious the very reason the SEC introduced five proposals to reinstating the uptick rule is to obfuscate people as the SEC has no intention to reinstate the original uptick rule at all so if you are counting on the uptick rule being reinstated to lift stocks further, you’ll be disappointed big time.

Steven Vincent said...

It appears my take was likely the correct one. VIX made a decisive break lower as the market broke out above major resistance on heavy volume. If markets do not break the current uptrend very soon, bears will begin to cover and reverse en masse leading to a very sharp rally to the SPX 200 DMA. This would coincide with a sharp drop on the VIX. Could Thursday's move be a head fake? It's possible but unlikely. But that's what stops are for. If you are short I would suggest covering on Monday on any weakness to support. Re enter shorts only on a close below the current uptrend channel.

Anonymous said...

Steven:

I really think we are headed back to the "devil's bottom" and lower in the next two months. I shorted some SSO on Friday for this and will be aggressively shorting on any weakness in ES futures. I agree with you the VIX is trending lower in general but the market is also headed lower. This market is convention-defying and chart analysis may not always work. Witness how often Rob (of Quantifiable Edges) and "Frank" (of Trading the Odds) are wrong and you know the limits of technical analysis.

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