Time Is Out of Joint

What’s going on with the VIX? The CBOE’s volatility index, which measures the implied volatility of the S&P 500, has suddenly become aligned with the underlying index. On Monday, both the VIX and the market rose. Yesterday, both lost ground.
That ain’t right. The two indexes disagree with each other more than 80% of the time. Two-day agreements are rare, three straight days is peculiar, and we’ve only had one stretch of four days in a row of alignment in the last three years.
The WSJ looks at some theories:

There are differing views about what is going on here, but the consensus seems to be that it is best to assume that yesterday’s move was really just a correction of Monday’s move, and that by now, things are where they belong.
Frederic Ruffy, analyst at Optionetics Inc., thinks the out-of-tandem moves aren’t coincidental. Instead they are evidence of an adjustment in volatility expectations. This is a “sign that participants in the options market are recognizing that the market is more volatile now,” he said. “There are some long-term trends that are causing volatility to rise,” like interest rates, political uncertainty and concern about energy prices.
Because volatility expectations are an important part of options prices, the market could be saying that “the premiums for selling and buying S&P 500 options should be higher,” Mr. Ruffy said.

The VIX has indeed been climbing lately, although at around 15, it’s still pretty tame stuff. The Era of High Volatility (i.e., the first four seasons of Sex and the City), routinely gave us VIXens in 30’s and 40’s.
Since the market finally turned, volatility has melted away. For a brief shining, and disvolatiled moment on July 20, the VIX dipped into the single digits. Even a month ago, the VIX was still around 12.
In The Economist, Buttonwood notes that the more volatile environment has been accompanied by changing events.

But low inflation, low interest rates and untroubled confidence in safe hands at the helm are fast becoming things of the past. Oil-price hikes have helped to push up inflation around the world. The Fed was expected to raise short-term rates again on Tuesday, to 4%, and looks likely to do so at least once more in the next three months. The European Central Bank may soon follow its tough talk on inflation with some tough action. Japan is more likely to raise rates than to cut them. Alex Ypsilanti, a strategist at Merrill Lynch, points out that over the past ten years the troughs in volatility have come one-and-a-half to two years after the low points in three-month dollar LIBOR (interbank) rates. The Fed started raising rates 16 months ago.

What does it all mean? Perhaps the era of high oil, trading ranges, low volatility and low long-term interest rates is coming to an end. As is often with financial markets, important turning points don’t announce themselves. At least not until they’ve made themselves quite comfortable.
I get the feeling that the times they are a-changing. Even the Japanese market made a new high yesterday. Although they had a little trouble when a computer glitch shut the market down. Apparently volume has exploded and no one saw it coming.

Posted by on November 2nd, 2005 at 6:08 am


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