August 23, 2010: If the VIX was a Stock
August 23rd, 2010
Traders use the level of the VIX (CBOE Volatility Index) as a validating gauge on whether a market move is normal or extreme. According to the CBOE’s website, the VIX is a “key measure of market expectations of near-term (thirty day) volatility conveyed by S&P 500 stock index option prices.” This index is generally known as “the fear gauge”. Rising levels are considered increasingly bearish and falling levels are considered increasingly bullish as option traders’ aggregate bets are continuously assessed.
Through a mathematical calculation, the level of the VIX is intended to predict the expected percentage move of the S&P 500 over the next thirty-days. Currently, the VIX is 25.61 which says that option traders (at the moment) expect the price of the S&P 500 to move up or down by 2.61% in the next thirty days. Since the VIX is a rapid interpretation of the near-term trend based on positions already taken by option traders, that interpretation can quickly change and is somewhat of a lagging indicator.
Looking at the price trend of the VIX from a technical perspective, it appears to be suggesting higher prices (a bearish indicator for underlying S&P 500). 2010’s low came on April 12 at 15.23. This ”trough” came ten days before THE cycle high for the S&P 500. During that ten days, the index rallied 2.1% but abruptly reversed into a nine-week, 17.1% decline.
Since April’s low, the VIX set a higher low at 21.36 on August 9.
2008’s low for the VIX came on May 19 at 15.82 which was followed by a higher low on August 22 at 18.64. On May 19, the S&P 500 peaked at 1440.24; a lower high than 2008’s high (January 2 at 1471.77). From the May 19 peak in the S&P 500 (low for the VIX), the index accelerated into a ten-month, 53.7% decline.
The current rising trend for the VIX is a strong indication that option traders are beginning to position for a significant negative reversal in the S&P 500.
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