Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Beyond The Stock Market VIX Volatility Index

Stock-Markets / Volatility Apr 21, 2011 - 02:32 AM GMT

By: Tony_Pallotta

Stock-Markets

Best Financial Markets Analysis ArticleI have traded options for a number of years and fully understand the "greeks" as should any active options trader. When you understand options you realize how valuable of a tool they are for investing, managing risk and understanding market sentiment. They are not as risky as many think. Before I share a rather important chart, I think it is important to go over a few option basics to fully appreciate what the data is telling you.


Implied volatility (IV) is one of the most important elements of how an option is priced. The simplest analogy is that of supply and demand. When traders are buying a specific option they drive the IV higher. When they are selling they drive it lower. The technical answer is based on a theoretical pricing model like black scholes, IV is the value needed to equate to a given price.

Ahead of company earnings for example, investors buy puts or calls causing the IV to rise. Once earnings are over, IV falls and so does the price of the options. Stay with me here and I promise to keep it as simple as possible. IV varies across time and strike price and is not linear, in fact if you graphed the IV for various strike prices you would see a "smile." This smile though is not uniform and in fact shifted more towards puts and less towards calls.

The chart below shows such an "IV smile" both pre 87 crash and post. Notice how volatility is higher for puts (left side of the curve) and lower for calls (right side). The more fearful investors are the more they buy puts and less they buy calls. The result puts generally have a higher IV than calls.

The VIX is the widely used measure of fear in the market as it measures implied volatility on the S&P 500. The lower the number the less fear, the higher the more fear. The CBOE though realized that the VIX does not capture the true picture of fear and or complacency in the market. Since the 1987 crash, investors have realized there is a risk of another crash and buy further out of the money options. In 1990 the CBOE created the CBOE Skew index which specifically measures these tail risks and how investors are pricing them in.

That's the class, now the chart. Below is a chart of the Skew Index VS the VIX from January 2008 to present.

Notice how since the March 2009, the Skew Index has actually risen while the VIX has fallen. The VIX has really given a false sense of security.

More importantly notice the two green boxes. The first is the flash crash of 2010. Notice how the VIX makes new lows while the Skew index makes new highs. Then once the market place reacts to falling asset prices, the VIX rises while the Skew Index falls. Now look at the next green box. The same exact divergence is occurring. Last month's selloff is even reflected.

The VIX is flashing a bullish divergence right now with the daily MACD which combined with the above chart should send chills down anyone who is overly leveraged and long this market right now.

If all was well, why would professional traders be speculating in out of the money options versus retail traders who based on the current VIX level are very complacent and have little to no insurance on their longs.

By Tony Pallotta

http://macrostory.com/

Bio: A Boston native, I now live in Denver, Colorado with my wife and two little girls. I trade for a living and primarily focus on options. I love selling theta and vega and taking the other side of a trade. I have a solid technical analysis background but much prefer the macro trade. Being able to combine both skills and an understanding of my "emotional capital" has helped me in my career.

© 2011 Copyright  Tony Pallotta - Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in