Wednesday, December 22, 2010

VIX and the Week Before Christmas

I guess I should not be surprised that a VIX of 15.45 – the lowest since July 2007 – has all manner of pundits scrambling to pull some sort of explanation out of a hat and weave it into their favorite bullish or bearish forecast for the markets.

In fact, the new low in the VIX is not a big deal, at least during this time of the year. I have talked about this before on a number of occasions, including in VIX Holiday Crush and earlier this week in Chart of the Week: Historical Volatility Plummets in Seasonal Swoon. Call it the holiday effect or calendar reversion, but when the VIX’s 30-day window includes two holidays and two additional historically slow days in advance of the Christmas and New Year’s holidays, volatility has a tendency to take a vacation.

How strong is the tendency toward a low VIX? Well, consider that in five of the last eight years, the annual low in the VIX fell during the week leading up to Christmas. Last year, some may recall that the VIX made its annual low on Christmas Eve. Back in 2004, the VIX had its low for the year on December 23rd; and in both 2003 and 2006, the VIX bottomed out for the year on December 18th. Today’s low makes it five pre-Christmas bottoms in eight years.

So keep a close eye on the VIX and feel free to marvel at how low it goes, but consider that during the holiday season, experienced investors will give very little credence to the absolute level of expected 30-day implied volatility in S&P 500 options. Only after the first of the year should we take the VIX numbers seriously, regardless of how low prices and implied volatility levels may be marked down in the pre-Christmas shopping rush.

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