Tuesday, February 27, 2007

VIX Overreaction?

Kudos to David Merkel at The Aleph Blog for pointing out that with the VIX up 21% and the SPX down 1.5%, the ratio of the two moves is -14, well above the typical -8 to -10 range.

This obviously supports the thinking that today’s moves are out of proportion to the fundamental events that are driving them and should serve as a reminder that the current environment is in no way as dire as some of the past crises that have caused the VIX to spike 20%. In fact, the magnitude of today’s move may be as much a result of the coiled spring effect (number of days without a 2% correction, etc.) or the volume of the recent bear drumbeat as any fundamental changes in the Chinese economy, geopolitical issues, US durable goods and the like.


David Merkel said...

Hey, thanks for picking me up. My blog is new, but I've been a commentator at RealMoney.com for 3.5 years.

Here's a use of the VIX you probably haven't run into. I used to be a corporate bond manager, running insurance money for a top 50 company. During 2001-2003, I would use the VIX to help me time trades. I would keep a screen with four graphs -- the S&P 500, the 30-year Treasury, the 10-year swap rate, and the VIX. On volatile days, the VIX would rise, and I'd sit on my hands until the VIX crested and typically, the market bottomed. I would then place my trades in the midst of the panic, and then lighten up on other days when the VIX would be in its usual mean-reversion process, decaying at a rate of 20%/month back to my hypothetical mean-reversion level of 16.

Also, since I'm also a life actuary, my VIX model was used to develop investment strategies for Equity Indexed Annuities. Worked really well, and gave me confidence as a bond manager in the high correlation between average credit spreads and the VIX.

Again, thanks.

Bill Luby said...

Thank you, David, for weighing in here and commenting on your experience in using the VIX for some setups.

I would be remiss if I didn't mention that your blog is off to a flying start in terms of content and style; I particularly like the breadth of investment-related topics. Even though you are still unpacking, I am already a regular reader.

David Merkel said...

Thanks, Bill. Many thanks. I have a lot more to do at my blog. I am maybe 5% of the way there, so stay tuned.

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