VIX and More 2009 Year in Review

While I thought the Top Posts of 2009 captured many of the high points on the blog during the past year, I also believe it might be interesting for readers to hear about which posts were some of my favorites.

Looking back at everything I wrote in 2009, I suspect that my most important work was probably with VXX, the iPath S&P 500 VIX Short-Term Futures ETN. I believe I was the first to analyze VXX in any detail, discuss some of the shortcomings and ultimately tie it all together in Why the VXX Is Not a Good Short-Term or Long-Term Play. Along the way, I think VXX Calculations, VIX Futures and Time Decay was the piece that shaped the thinking of many investors. In terms of timeliness, VXX Juice Factor and Portfolio Insurance Implications was a warning shot I fired in the first month after VXX was launched.

While volatility declined almost in a straight line for the entire year, stocks did not. In retrospect, The Possibility of a ‘Stealth Bottom’ was one of my best predictions and my March 5^th SPX at 687; Intermediate Bottom Potential Is High was only one day early.

Some of my favorite posts of the year were related to how to think about trading. The Trader Development Stage Model – Version 2.0 was a way for me to articulate some of my thinking on the subject of how traders evolve. In The Trader Development Stage Model and the Jump from Stocks to Options I liked how the model explained how and why new options traders get into trouble. A precursor to the model was a pair of posts Kafka, Surrealism and Trading and Comfort Zones, Focus and Thinking Like a Biotech Firm which address trading strategy development. Earlier in the year, Can Options Selling Make You a Better Trader? probably got the wheels turning about some of the elements of superior trading performance.

In another impromptu series of posts, I dipped my toe into behavioral finance in Availability Bias and Disaster Imprinting. The ideas from that post became much more compelling when I tied them back to the VIX in The VIX:VXV Ratio, Availability Bias and Disaster Imprinting and later in VIX Data to Support Availability Bias and Disaster Imprinting Hypothesis.

It turns out that the behavioral finance posts and several posts on realized volatility shared some analytical ideas. In The Gap Between the VIX and Realized Volatility I posted my what I believe is my first graphical representation of the difference between the VIX and realized volatility. When that extended gap finally came to an end, I posted about it in Chart of the Week: No More Free Lunch for Volatility Sellers?

With other voices now regularly discussing the VIX, I don’t feel the need to post on that subject as much as I once did, but my incredulity recently boiled over in The VIX Spike Conundrum after I saw many pundits essentially suggesting that investors panic along with the crowd.

Last but not least, two of my favorite humorous interludes were Roubini and the VIX and Blogging Network a Better Buy than Business Week?

On a personal note, I am delighted to say than in many instances it was reader comments and private emails which provided the inspiration and kicked started a dialogue of ideas that eventually resulted in some of these posts. I continue to be surprised by the extent to which blogging is a collaborative process and am thankful to all who have made my life richer in 2009 by sharing their questions and insights.

Disclosure: none

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 6^th, 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 23^rd, 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 10^th and March 12^th 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.

The Possibility of a ‘Stealth Bottom’

The more I hear about the need for some sort of dramatic capitulation to affirm that a bottom has been made, the less likely I think it is going to happen. Instead, my thinking is that the longer and steeper the bear market, the more likely that any sort of capitulation will happen in stages.

Frankly, I find a scenario like the 2002 NASDAQ bottom to be a better template for a bottoming in the current market environment than most of the other possibilities that have been discussed. In VIX Spikes and the 2002 Market Bottom, I noted how the dot com bear market saw five VIX spikes of decreasing magnitude and ultimately found a bottom on a relatively small VIX spike and unremarkable volume. In short, it was a stealth bottom.

I would not at all be surprised to see the current bear market end in a similar stealth bottom. Sometimes a desensitized investment community is more likely to form a bottom than a panicky one.