Wednesday, July 9, 2008

The Impact of Financials and Energy Stocks on the VIX

The rapidly changing fortunes of financial institutions and energy stocks have been widely chronicled – so much so that there is no need to repeat the details here.

The implications of the shift away from financials and toward energy touch upon several issues that I have not yet seen addressed in the media. One of the obvious ones is the composition of various stock indices. In the S&P 500 index (SPX), for instance, just from 2007 to the present, financials have dropped from 22% of the index to 14% of the index, while energy stocks have surged from 10% to 16% of the index. The change is particularly important when one considers that financials (XLF) have historically been highly correlated to the SPX (0.91 over the course of the past year), while the energy sector (XLE) has typically had the lowest correlation to the SPX (-0.28 for the past year).

Consider that in the past year, the index has been tilting away from financials and toward energy stocks, essentially swapping a positive 0.91 correlation for a negative 0.28 correlation. Given that the VIX is based on SPX options, there can be little wonder why the VIX has been moving more lethargically as of late: an increasingly dominant sector – the energy group – is pulling in the opposite direction of the other sectors. The result? Sector gridlock is dampening the movements of the SPX and of SPX derivatives, like the VIX.

[Hat tip to Adam at Daily Options Report and Don at Don Fishback's Market Update for jump starting some of my thinking on this subject.]


Bill Luby said...

Since I posted this, Don Fishback has posted his own much more detailed study of volatility, correlation, and the VIX that has to be considered the last word on the subject -- at least for now.

Check out Index Implied Volatility Is Based On Correlation and Time — It’s Not Just Magnitude! for all the details.

Anonymous said...


How hard would it really be to manipulate the VIX?

I think not very.

Anonymous said...

I quoted part of your excellent observation regarding the lethargic VIX on my website:

DISCLAIMER: "VIX®" is a trademark of Chicago Board Options Exchange, Incorporated. Chicago Board Options Exchange, Incorporated is not affiliated with this website or this website's owner's or operators. CBOE assumes no responsibility for the accuracy or completeness or any other aspect of any content posted on this website by its operator or any third party. All content on this site is provided for informational and entertainment purposes only and is not intended as advice to buy or sell any securities. Stocks are difficult to trade; options are even harder. When it comes to VIX derivatives, don't fall into the trap of thinking that just because you can ride a horse, you can ride an alligator. Please do your own homework and accept full responsibility for any investment decisions you make. No content on this site can be used for commercial purposes without the prior written permission of the author. Copyright © 2007-2023 Bill Luby. All rights reserved.
Web Analytics