Implied Volatility Suggests Financials Risk Is At Six-Month Low

Just yesterday, in Financials Struggle to Establish Momentum, I expressed some concern that the recent relatively weak performance of the financial sector (XLF) did not bode well for any sustainable bull moves. Perhaps the sector overheard me, as today the XLF is up 2% in an otherwise flat market as I type this.

While the price action is ultimately what matters most, there is more to the story than just the prices of the financial stocks. In particular, I am watching the implied volatility of XLF, the financial sector’s bellwether ETF. As depicted in the chart below, the implied volatility (which has a significant fear and anxiety component in it) for XLF is approaching levels not seen since the first week in November. (Click chart to enlarge.)

I consider option traders to be a fairly savvy bunch; if they think that the risk premium in the financial sector is lower than any time in the past six months, I am going to listen – and watch to see what happens to the price.

Comments

[pairadox:]

I saw that the chart pattern of xlf was trending up and bought in at 25, but after two cycles got off the train while there was a profit to be had, albeit only 3%. My original intent was to hang in for the longer term, but the news has been so negative lately, that a break in the up trend to another step down seems inevitable and imminent.

2008 Apr 25 12:51 PM

[Matt Blackman:]

Interesting opinion except for one fairly major point. Options traders really aren't any smarter than your average stock bull or bear if the CBOE Put/Call ratio is any indication. A high put/call ratio is as good a contrarian indicator as it gets - the best time to go long is when there are the greatest number of puts compared to calls (when options traders are the most bearish) and vice versa.

Also, using the VIX or any other volatility indicator as the rationale for making a trade will prove very costly as you will find if you backtest such a strategy.

2008 Apr 25 01:54 PM

[ajhough:]

I find the VIX to be interesting but not a good indication for trading. I may just not know exactly how it works since I am an investor, not a trader. Traders evidently are the ones who are making money in this market. Implied VIX is above my pay grade.

2008 Apr 26 10:43 AM

[adenovir:]

I always thought that when volatility was low, it meant that market participants were complacent. Doesn't that seem like a better setup for a high than a low? It's peaks in the volatility that tend to mark bottoms, not valleys.

2008 Apr 26 12:53 PM

[oldman:]

I am not a trader, therefor do not use Vix for decision making. To make an investment, use trends, support, resistance and wait to buy when these are in your favor. Not worth bottom picking for me.You may not buy at the bottom but you can make money.

2008 Apr 26 05:43 PM