Saturday, May 23, 2009

VIX and stocks run in opposite directions

The VIX (CBOE Volatility Index®), or "investor fear gauge", measures market expectation of near-term volatility, as conveyed by a range of S&P 500 index option prices (both calls and puts). It is, essentially, the price of buying options in order to protect stocks.

A high VIX value is seen as a greater degree of market uncertainty, while a low value reflects greater stability. As the graph below shows, when the VIX goes up, the stocks go down (S&P, Dow, NASDAQ). Conversely, when the VIX goes down, the stocks go up. Hence, an investment in iPath S&P 500 VIX Short-Term Futures exchange traded notes (which track VIX futures) can act as a bearish hedge.

Other volatility indexes: VXN tracks the NASDAQ 100, VXD tracks the Dow Jones Industrial Average, and MVX tracks option prices on the S&P/TSX 60 index ETF. Note that Vicks is another thing entirely.

VIX chartA couple of questions arise:
  • Q: Are rising volatilities almost always a precursor to falling stock prices, as the market wizard stated in Steven Sears' Barron's article, or are falling stock prices the cause for rising volatilities?

    A: Yes.

  • Q: What is the relationship between VIX and Viagra?

    A: With all due respect, it seems that the markets do just fine without Viagra, in particular when the VIX comes down.

1 comment:

  1. What's the relationship between the VIX and beer and fries (and perhaps globalization), that's what I'd like to know...