Time to Buy Volatility?

With the S&P 500 rallying and the VIX Index on the verge of breaking technical support, which way is volatility like to go? Bill Luby at VIX and More says that the VIX could be regarded as either high or low, depending on the time frame.


How fat are the near-term tails?
There are indications that we could be in for a fat-tailed event. Tyler Durden at Zero Hedge speculates that the behavior of quant fund returns indicate that we could be in for another blow-up:

"Anyone who is doing anything sensible right now is either losing money or is out of the market entirely." These are the words of a quant trader, who is seeing something scary in the capital markets. Scary enough to merit a warning that we could be on the verge of another October 87, August 2007, or January 2008...

He pointed out that the runup was accomplished on low-volume, which may not be sustainable [empahsis mine]:

[T]he Volume Weighted Average Price of the SPY index indicates that the bulk of the upswing has been done through low volume buying on the margin and from overnight gaps in afterhours market trading. The VWAP of the SPY through yesterday indicated that the real price of the S&P 500 would be roughly 60 points lower, or about 782, if the low volume marginal transactions had been netted out.

Durden believes that the fast quant fund money is withdrawing to the sidelines. As many of these funds are liquidity providers, this suggests that the market could be setting up for a period of high volatility should any market participant try to come in to buy or sell in size. (Read his whole post here and follow-ups here and here.)

This is very intriguing analysis. If Durden is right, then is it time to buy volatility?

Comments

[Jim Hawthorne:]

A pullback at this point would be both fundamentally healthy and a near technical necessity...

The VIX will bounce from support. Prudence dictates profit-taking!

Apr 14 08:52 AM

[Jim Hawthorne:]

Why not just throw ALL the paddles out of your canoe while you're at it! Do you not realize that we are ALL still up the creek???

On Apr 14 09:01 AM Cetin Hakimoglu wrote:

......."The VIX is no longer interesting or meaningful..."

Apr 14 09:24 AM

[Mad Hedge F...:]

I'm still a seller. There is a great debate raging in the markets right now over the stubborn persistence of the volatility index (VIX) remaining over 40%. Is it still too risky to go back into the market? Are we going to new lows? Is the next big move an updraft or a downdraft? Part of the confusion springs from a misunderstanding of what the VIX is. It is just a mathematical guess about how big the next move in the market will be. A 40% VIX implies that one out of three days will see a 2.25% palpitation, and once a month we will suffer a 4.5% gyration. You can have the market drop 10%, rise 11.1%, remaining unchanged, but still generate a tremendously high VIX. The equation doesn’t care what the direction is. VIX unfairly picked up a bearish connotation because of the panicked rush by long side only investors to buy downside protection in falling markets, driving put implied volatilities through the roof. This is why investors associate a high VIX with falling markets. In the end, this debate can only be resolved in one way, and that is to the downside. Smart hedge funds are now shorting out of the money calls on VIX. VIX will crash when markets go to sleep, as they inevitably will. Be careful what you wish for. Traders don’t pull down million dollar salaries playing “Solitaire” on their computers.

Apr 14 09:28 AM

[ain't no fo...:]

Mr. Hui, thank you for your article, and for the link to Tyler Durden's article. I have been watching volume fall off as this rally gets long in the tooth, now the pieces are falling into place.

Apr 15 09:11 PM

[E Nuff Sed:]

The S&P 500 weekly volume looks quite good to me. Not sure where durden is coming from. I find his writing too complex and full of jargon.
www.bestfreecharts.com...

Apr 19 08:36 PM