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Moby Waller
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Moby Waller is a former CBOE Market Maker floor trader and off the floor London-based European Index Options Trader. He is co-Portfolio Manager of the ETFTRADR http://www.bigtrends.com/etftradr-advisory-service/ & Rapid Options Income ROI... More
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  • Examining the VIX Pop 0 comments
    Aug 11, 2010 6:57 PM | about stocks: VXX, VXZ, SPY, SPY
    With today's market selloff we saw a big rise in option implied volatility.  The CBOE Volatility Index (VIX) moved over 13% higher to close at 25.39.  A rise in the VIX is due to several factors such as an actual rise in market volatility, the fact that implied volatility goes up on market down moves quicker than it drops on market rallies, and from supply/demand.  By supply/demand, this means a large amount of option buying occurs from the public, which then causes market makers to raise the premium on option prices.  This can be seen as "panic put buying" when the market sells off. 

    The third chart below is the CBOE Equity Put/Call Ratio (which we examine every night along with other sentiment indicators in BigTrends Trader's Edge).  You can see a large spike in this indicator today to a fairly extreme level above its top Bollinger Band -- although on an absolute basis we did not surpass a 1.0 reading that would indicate more Puts were traded than Calls.  Normally spikes in the EPCR and VIX to extreme levels can mark a short-term bottom in the market, but this isn't necessarily the scenario currently.

    Let's take a look at the recent VIX patterns.  The top chart is the VIX Daily.  You can see that the higher VIX levels began in April of this year.  Since that time, the VIX has bottomed out at different, higher levels on several occasions.  Remember that high VIX levels such as above 30/35 are fairly unusual, and that the VIX has a tendency to want to go lower and settle into a range naturally.  The VIX only will rise significantly during times of panic, volatile trading, etc -- otherwise it will drop towards a natural range.

    Certainly since 2007 we've seen a new higher range on the VIX than was in place for the years previous (second chart below).  An interesting rule of thumb for the actual VIX value is that it can represent what the market projection for the 12 month range on the S&P 500 Index (SPX) will be -- so a VIX of 25 indicates a +/- 25% on the SPX for the next year.  Hence, when the market was going up 10 to 15% a year, the VIX was quiet in the 10 to 20 range.  With the more volatile corrections and retracement rallies we've seen recently, it's largely been in a 20 to 35 range.

    So recently we've seen the VIX pop when it tests lower levels as the market has had sharp downturns periodically.  The level of the reversals has gotten lower and lower on the VIX, however.  24, 23, and now 21.5 have marked VIX reversal areas, as we look to be on an eventual course to test the 20 level, which I've mentioned previously as an anticipated target for 2010.

    On the Weekly Chart, you can see that a big longer-term downside target for the VIX is the 15 area.  This is where we've had multiple VIX bottoms since 2007.  The days of a VIX range of 10 to 20, as we saw from 2003 to 2007 and from 1993 to 1997, are not likely to return for some time.  Note also how the VIX Weekly Chart looks to be forming somewhat of a "head and shoulders" technical formation -- I would take this as with a grain of salt however, as the VIX is more of a sentiment & panic measure than a technical, trending type of security.

    VIX Daily Chart
    dtw081110vixb

    VIX Weekly Chart
    dtw081110vixa

    CBOE Equity Put/Call Ratio Daily Chart
    dtw081110epcra


    Disclosure: No positions.
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