VIX Suggests Changes in Selling Behavior

With the plunge in equity markets over the past 18 months or so, investor attention has often turned to the VIX. A popular measure of investor fear, the Chicago Board Options Exchange’s volatility index surged above 80 late in November.

The Nov. 20 peak of 80.86 for the VIX coincided with what was then an 11-year low for the S&P 500. Since then, the volatility gauge has plunged. So it wouldn’t be surprising to expect a bullish tone from those who use it as a contrarian measure, but equities have fallen further.

With the VIX hovering around 50 these days and with it failing to break above 53 since January, there appears to be a new kind of selling taking place in the market.

“Broadening selling without heightened fear suggests that shorting stocks has become more of a proactive strategy than a reflection of forced redemptions, margin calls,” said Ashraf Laidi, chief market strategist at CMC Markets in London.

He told clients that the failure of indices to rebound more than 25% off their November lows was a vocal signal of a persistent bear market rally. During the 2000-2002 bear market, there were four rallies in the S&P 500, each gaining no more than 26%, the strategist noted.

While the more optimistic view argues that a more subdued VIX signals a market bottom, Mr. Laidi said neither the ongoing decline in housing prices nor the coming wave of bank and auto nationalizations suggests a bottom in equities.

Comments

[MMMPARSLEY1:]

Are you guys all sleeping? The market will all do what nobody is expecting it to.

The next move is going to be a short squeeze of historic proportions, for not other reason than the market is over-shorted.

Nobody is saying it, that is exactly why it is going to happen.

Dave

Mar 07 05:00 AM

[MJJP:]

I think what many are discounting is the meteoric rise in online trading by individuals with no clue about investing.The market has become for many a craps table with slightly better odds. All those charts of the past may in fact be obsolete and not applicable this time around.

Mar 07 05:12 AM

[Fighting Yoda:]

VIX at 50 is no sign of complacence. 50 seems low just because it has come down from 90. It simply means the pace of decline is slower and more orderly – no daily redemptions and margin calls.

However the bearishness is extreme with no end in sight, Friday late recovery was simply a short covering on a weekend- bears made enough money to relax for the weekend.

Markets should continue to fall –perhaps till 500, sell out.

Mar 07 05:45 AM

[AndrewBaker:]

One reason for the VIX not going substantially back above 50 is that with the S&P 500 where it is now, few people expect a large rise or fall will occur in the next 30 days, so not so many out of the money put and call options are being sold or bought. I am not an expert in the calculation process, but understand that the volatilty rises in relation to the expectation of change, but that doesn't mean changes in the S&P can't be substantial regardless, so for me, a VIX of 50+ still suggests plenty of room for big price moves, and at the moment these are likely to be downwards. Apart from gold miners and maybe oil (short term), I'm staying with puts; although I am trading the financials up and down with varying success!

Mar 07 08:35 AM

[Tesa:]

The lower VIX means that the market has taken out all the fearful and those that are left are no longer the traders but rather the funds who trade the US markets who hold the pension plans that have collapsed. Now you should you try to work to suck more money out of this markets, you cant produce more fear because people who have lost 90% of their investments don't give a rat ass anymore. Hopefully you will lose 90% of your investments to make up for their loss.

Mar 07 09:28 AM

[joshuaodonnell:]

Will see DOW at 4500(we wont go straight down) but ultimately will get to 4500. We haven't even seen capitulation yet! Maybe this week? maybe. it all depends on the news.

Mar 07 09:36 AM

[t-bird:]

In addition to the above items regarding the current state of the economy, you can add the collapse of consumer credit (AXP, around $10), and the decimation of commercial real estate that is only in the third inning of a nine inning contest...

Do agree we may have a significant short covering rally that will be of some significance and may last for several weeks. The uninformed will be touting a major bull market is upon us... However, technicians such as Louise Yamada suggest the Dow averages may decline to 4-5K during the course of the year...

Mar 07 09:36 AM

[Hari Seldon:]

The VIX is a reflection of uncertainty and volatility in the market. It peaked at a time when people recognized there were problems but did not yet understand the extent nor what the government reaction would be to the problem. Since then, it has become clear that things are much worse than expected then and uncertainty has been removed as a result (eg people expect stocks to continue to move down).

I believe the VIX peaked largely at the same time that the skew changed from positive to negative (eg sellers of puts started demanding more of a premium than sellers of calls).

As a fundamentals guy, I find it the logic that "because VIX has moderated we could see a rally" an incredible fallacy. Stock prices are chasing declining earnings at this point and I see few positives in the earnings numbers I get to look at for some private companies. November and December were just terrible and January wasn't been much better.

Any rally will simply be a result of short-covering and nothing reflecting the fundamentals. I'd continue to suggest selling into any rally and taking profits from those shorts when the market returns to its low.

Mar 07 09:58 AM

[Bruce Pile:]

If you examine a chart of the VIX going back 10 years, you see that every single new bear market low is accompanied by a sharp climb of the VIX. This is the history:

3/'01 9/'01 7/'02 (last bear market - VIX climbed to 35-40)
6/'06 2/'07 (bull market selloffs - VIX climbed to 20)
8/'07 1/'08 3/'08 7/'08 (early bear market - VIX climbed to 30-35)
10/'08 11/'08 3/'09? (present bear market - VIX climbed to 80)

The argument that "it's different this time with the VIX" doesn't square with history very well. Consider that all these previous fear peaks was fear of many diverse things, terrorist attacks and various new market lows with and without delevering episodes. And note that the fear level is commensurate with the overall situation with the peak VIX values varying from a low of 20 in late bull market mode stair stepping to a high of 80 in our present evolving mess, which is worse than the '02 mess.

Maybe we can make a new market low without the VIX spike, but it would really be out of whack, being the first time in modern history!

Mar 07 10:22 AM

[Sicall:]

I think there is too much emphasis on the actual Vix number which maybe doesnt tell us much.

Vix is supposed to tell us whether investors are buying insurance against the S&P in the Options market. So a figure of 50 is still high so does this mean things are better than when the Vix was at 80? maybe not

If there are 100 rats on an abandoned ship and 80 of them leave in November theres fear. If the ship remains afloat and the remaining 20 leave in March is there less fear?

What im trying to say is that now theres a big proportion of money on the sidelines is there less willingness to hedge to cover smaller positions?

Mar 07 10:39 AM

[squark62:]

sicall: interesting comment. it is hard to read what the VIX completely. i might suggest that all the panic sellers left in OCT-NOV 08. now you have a different type of seller - the strategic short seller. they manage their risk better so to place far out of the money puts and calls is not a good calculated risk, especially if an extreme short covering rally is eminent.

Mar 07 01:03 PM

[Rob Viglione:]

Relatively modest VIX level given higher-than anticipated volatility (as gauged by VIX) provides an excellent equity hedge. Buy long VIX to protect against equity downside.

Note: VIX ~ 50 is historically high, but certainly lower than the previous high of 82.

Mar 07 01:10 PM

[dcb:]

there was a very good article by kevin dewpew (sp) in Minyanville that mentioned trader psychology, and I believe quant funds are the reason we see falling stocks without and increasing vix. traders try to catch a falling knife and try to support each new fall level. from this level there is a slight bounce up, profits are taken this selling happens until a lower low is reached to find support. this process happens over and over. retail investors aren't in the game. Therefore you have a downward tragectory with each newer low gaining support and hence the fall is slowed and a lower vix. if you look at the volume spikes on the S&P will will quickly see it is computer driven and increases through out the day reaching max later in day. people traders see we are closing below the close of the day before and sell the lat 1/2 hour. in the morning futures are up, and sales drive the index lower. eventually we get a day when everyone sell (like Friday) when dow broke 6500) the programmed trading drives the market up since they are the only ones buying and up we go. seeing the upwards close causes further buying so we have a bounce up programmed selling the next day drives the new buyers to sell, and off we go again to a lower low. that is why it has been easy to make money shorting in the morning, and buying long later in the day.

Mar 07 01:22 PM

[Larrysyr:]

The fundamentals are awful. The S&P is currently trading at 13-14 P/E, based on 2008 earnings. I'd say another 20-30% down will only get the market into a reasonable range, from which a bottom may be visible. If earnings deteriorate (and why wouldn't they in this environment), the market could easily go down further.

The lower VIX seems to simply be pointing out that most investors realize we aren't at bottom yet.


On Mar 07 09:58 AM Gold is Good wrote:

.....

> As a fundamentals guy, I find it the logic that "because VIX has
> moderated we could see a rally" an incredible fallacy. Stock prices
> are chasing declining earnings at this point and I see few positives
> in the earnings numbers I get to look at for some private companies.
> November and December were just terrible and January wasn't been
> much better.
>
> Any rally will simply be a result of short-covering and nothing reflecting
> the fundamentals. I'd continue to suggest selling into any rally
> and taking profits from those shorts when the market returns to its
> low.

Mar 07 02:33 PM

[Stephen Str...:]

Vix of 50 isn't low. Blind panic has been replaced with a hasty move towards the exits.

The US may have led the UK into this, but banking is a bigger proportion of UK GDP and things are developing faster here. As the government policies are similar (ie bail out the people who lost the money at the expense of vast borrowing), it may be worthwhile to look to the UK to see how things go next in the US.

The UK story so far: the so called banks "liquidity gap" has been acknowledged at last to be a "solvency gap", and the government has taken on the vast and unknown liabilities of most of the banks in return for them restarting their lending. Quantitative Easy (QE) (ie monetising debt / printing money) has already started. Once the economy starts up again, we'll work out who pays.

Mar 07 03:05 PM

[Bruce Pile:]

The rats on a ship thing is an interesting analogy. You'd think that most of the rats would have left by now. Maybe the last few rats leave with more furiocity causing about the same VIX action.

There is an interesting chart comparison and article over at safehaven safehaven.com/article-... where the two bottoming periods '02-'03 and now are superimposed by SPX and VIX. You see that so far the two look like twins except that the SPX 3rd low was not a lower low in early '03 whereas early '09 is a new low. So the VIX pattern would have one more spike and the whole bottoming pattern is shifted in time by about two months with the present one lagging. It points out the seasonality effect on these two bottoming episodes, market crashes tending to occur in the fall and rallies tending to begin in the spring. The 3rd chart would have the present 3rd bottom proceed for a month or two, maybe to the often cited 500-600 area, running the VIX back up to fit the historical pattern I mentioned in the above comment before a large climb gets underway.

Mar 07 03:07 PM

[Mrudula Shah:]

The 80% VIX hypothesis of the past is based on market condition primarily n the U.S.A. when it was a vastly larger pie of the world. This time, not only the U.S. economy but the other leading world economies are also in shambles and investors (including mutual fund managers) all over the world have been unsure at present if the economy is about to turn around . Mutual funds in the U.S.A. have replaced increasingly or almost squeezed out private investors of the past as majority investors in the modern day equity markets. Naturally then, the outdated past hypotheses based the private investor psychilogy no longer hold good!! It is like professional gamblers versus poor, uninformed, scared private investors. Forget about all those outdated theories to predict the market bottom. This time, the market bottm will be when the professional gamblers at the mutual funds start moving their billions and trillions from treasuries and gold to equities. That time will come when they are convinced that the hundredes of billions poured by major governments of the world will begin working and greedy executives of the world's corporations have been removed or forced to learn their lesson, meaning when these companies have cleaned up their act to the satisfaction of mighty investors (i.e., major mutual funds of the world). Do not go by what the so-called mom&pop pundits, you see every day brought on TV by stupid half-educated TV reporters or in the media. (I keep Bloomberg channel on with "mute" on until I see Geitner or somebody like him there.) They simply do not have what it takes to predict modern-day market. For ordinary investors, I would advise to take just one day at a time and simply use their common sense and not listen to those "pundits"..

Mar 07 03:38 PM

[jrhc:]

Well said mruyog, not listen to those «pundits»... but at least reading them (or looking at them in CNN) helps to pass the time...

Mar 07 04:51 PM

[ron_paulite:]

"Nobody is saying it, that is exactly why it is going to happen."

You just said it. And so it is not going to happen.
You should've kept silent!

Despite the drop, the mood is still bullish.
Everybody is trying to call the bottom.
There are a couple of trillions in money funds waiting to go into stocks.
The bottom will come only when nobody is waiting anymore because everybody has lost all hope.


On Mar 07 05:00 AM mmmparsley1 wrote:

> Are you guys all sleeping? The market will all do what nobody is
> expecting it to.
>
> The next move is going to be a short squeeze of historic proportions,
> for not other reason than the market is over-shorted.
>
> Nobody is saying it, that is exactly why it is going to happen.<br/>
>
> Dave

Mar 08 01:43 AM

[robert.b.fe...:]

Small investors are still in the game but not to the extent they were before the NOV 08n crash. The VIX is vitrtualy meaningless to these investors as they are either hedging thier positions or bottom fishing for bargains. However they too have a lot of cash on the side lines waiting for the next fire sale.

Mar 09 10:02 AM