Wednesday, April 8, 2009

Waiting for the Next Shoe to Drop?

There has been a lot of speculation about which corner of the economy is likely to implode next and start to write the next chapter in the current financial crisis. Credit card debt and commercial real estate are two of the most frequently cited potential culprits, but lately Eastern European banks have been under great stress, while credit default swaps for Romania, Bulgaria and Hungary have been on the rise.

I did not realize how strong the undercurrent of fear was until I ran Today’s Jump in the VIX on Monday evening. From the various public and private comments, it is clear that there is a strong contingent of veteran investors who anticipate not only that the next shoe will drop soon, but that the fallout will be at least as bad as what we experienced during the October-November peak of the crisis.

While I am not ruling out anything at this stage, I do not see the VIX spiking above 60 in the near future, nor do I even see a VIX above 50 as a likely scenario.

Last Friday, the SPX had its highest close since the 666.79 “devil’s bottom” low of March 6th. From Friday’s 842.50 close to Tuesday’s close of 815.55, the SPX fell 3.2%. During this same period, the cash VIX gained just 1.7%, moving up from 39.70 to 40.39. In the chart below, however, one can see that even thought the cash VIX rose, the volatility index for SPX options in April, May, June, July and September actually fell, with volatility for the April expiration showing a 12.5% drop in the VIX, May volatility dropping 4% and the June through September strikes show a volatility decrease on the order of 0.9%-1.6%. In other words, expectations for volatility – and presumably fear and uncertainty – for the balance of the year continue to point to improvement.

Of course, there is always a group of traders who get fearful when the VIX fails to measure what they believe is an appropriate level of fear. This group, whose concern I can sympathize with from time to time, will undoubtedly see an indifferent VIX as a reason to be even more concerned about the future.

For now at least, the VIX term structure points to increasing investor confidence in the markets and a decreasing concern about the possibility of gravity commingling ominously with oversized footwear.

[source: CBOE, VIXandMore]


Pankaj said...

VIX formula is open for manipulation I feel at times. I mean how can you control the value of $VIX and say that it is touching the EMAs or supports, unless you literally flood put orders on indexes to pump the $vix.... Am I making any sense?

Douglas said...


Who would be manipulting the VIX and why?


Anonymous said...

did someone say the stock market is manipulated??? That's old news.


Anonymous said...

one immediate consequence of the vix's non-spiking when the market drops is that vix will lose its "sexiness". imagine the market's "fear gauge" suddenly loses its effectiveness to predict when the market will drop and the media will stop bombarding us with news how high the vix has spiked once again and they'll lose the opportunity to report these events in a sensational way. this is happening because some retail investors have been using the vix as buy and sell signals to time the market and some institutional investors don't like it. that's why they are shorting the market in a "stealthy" manner such that the vix remains depressed but the market drops anyway so retail investors' money is taken away "on the fly".

Anonymous said...

can we have two markets. A simple straightforward one that allows only investor of a million or less, and the other POS market that is so contrived that I would have better luck at a casino.

Eric said...

I am still looking at a new range of 33 to 40 for the rest of the month. I think we should see breakouts at the end of April when they announce the conclusion of the banking stress tests.

Anonymous said...

i don't know about the vix, but i saw a huge amount of put buying today in spx options and i suspect this is the end of this incredible rally.

Anonymous said...

Same arguement, by looking at the 30 years t-bonds with yield = 3.75%, do you think in the next 30 years the inflation is less than 4% in total? Perhaps, we just can't rely on just one index.

Besides, the VIX/VXV ratio is getting lower, the selling point is approaching. I don't have the data but I suspect 2008 March-May, the market was very similar to the present situation.

just my two cents,


Anonymous said...

i like your analogy of comparing now to may 2008. agreed. i mean this isn't oct 2008 but we are in may 2008 and we are headed to july 2008.

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