Thursday, April 29, 2010

VIX Unspikes as Stocks Rebound

How many days does it take to undo a 30% spike in the VIX? This time around, the VIX retraced 82% of Tuesday’s 30.6% VIX spike in just two days, a bigger reversal than I had anticipated. By comparison, the S&P 500 index reclaimed slightly less ground, recovering 73% of the 38.18 point loss.

The chart below details the most significant pullbacks since stocks bottomed in March 2009, with this week’s 3.1% drop being the 10th largest in 13 months and considerably below the average drop of 5.4% during the period. Note that a 5.4% pullback from a high of SPX 1219 would put that index back at 1153, which is very close to January’s high of 1150.

I have fielded quite a few questions on VIX options, VIX futures and VXX this week, many by readers who wish to know why these securities have been relatively placid compared to the seemingly more dynamic cash/spot VIX. The reason these securities have not retraced as much of Tuesday’s spike as the VIX is because while VIX May futures rose 2.3 points on Tuesday, they have only fallen 1.4 points or 61% in the past two days, largely due to the fact that mean reversion expectations are built into the pricing of VIX futures.

Ultimately the numbers will take back seat to the fundamentals of the European debt crisis, where there has been more evidence of contagion in Portugal, Spain and even Italy where yields on sovereign debt have increased dramatically in the past few days.

The SPX fell 6.5% during the relatively short-lived Dubai debt crisis of October-November 2009. The likelihood that the current European debt crisis will be resolved as quickly and smoothly as the Dubai situation strikes me as remote, which is why I will be looking to take profits on short volatility positions quickly.

For more on related subjects, readers are encouraged to check out:

Disclosure(s): Short VIX and VXX at time of writing

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