Wednesday, July 9, 2008

VIX...Is It Broken??

Starting last week I started pondering the notion that to many people were looking at the VIX. As a result the indicator may not be a good indicator at a market bottom this time around. You can't watch CNBC for an hour without somebody mentioning it. Like anything in markets there are no rules!! Only guidelines. A VIX reading of 30 is no magic number despite every one's assumption that it is. It could be 25 or 40. 30 is just a number that becomes important because enough people believe it. Of course I am watching it but I am not convinced we have to see a VIX reading of 30 to start a rally. We may or we may not. I hear people talking about the VIX who didn't even know it existed 6 months ago and I have to wonder what that means.

Anyway a great article on online Barron's talking about this echoing alot of my thoughts.

Because of this supply/demand imbalance, implied volatility typically trades at a higher level than the mathematics would predict for a perfectly efficient market. However, if the S&P 500 can only be expected to move -- up or down -- 15% over the next 12 months, isn't it odd that so many perceive a VIX of 25% to be unusually low? After all, a 25% VIX translates to a 67% premium over historical norms!

and maybe because we are not getting a spike is because short interest is up over 55% on the NYSE compared to last year causing investors to be more comfortable and less fearful about their portfolios.

Those who were overleveraged or overexposed to stocks have spent the last several months reducing their long positions. Indeed, this is confirmed by the latest readings from both Investors Intelligence and the ISI Hedge Fund survey, which show bearishness, and hence defensiveness, approaching historical extremes. If investors are in fact less invested than they were, they don't require as much insurance as they did during previous market declines, and this could explain why the VIX hasn't reached the relatively high levels of January and March.

Does this mean the VIX will pull back from here, and the stock market will rally? Not necessarily, but the premise that stocks are headed lower on a short-term basis because implied volatility is only trading at a 67% premium to realized volatility seems bogus.

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