Lack of volatility and a perceived stable market: what do we mean?
June 15 2014
Many commentators, journalists and hedge fund managers are talking about the low volatility in the markets which is foreshadowing a possible dip over the summer.
The VIX is at its lowest level since 2007 and markets are at record highs. This is leading a number of analysts to forecast a minimal 20% correction within six months.
However, despite this, we foresee very significant price declines and jumps for individual stocks and sectors.
The relative stability of the major market indices hides significant volatility in individual stocks such as Cisco, Intel, Symantec, Cliff Natural Resources, and even sector indices (Biotech).
Therefore an analysis limited to major indices may be misleading.
I. Volatility - VIX
VIX is a trademarked ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the volatility of S&P 500 index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 days.
The VIX is a measure of market price expected volatility in either direction. When investors anticipate large upside volatility, they are unwilling to sell upside call options unless they receive a large premium. Option buyers will be willing to pay high premiums only if they anticipate a commensurate large upside move. The resulting aggregate of increases in upside stock option call prices raises the VIX as does the aggregate growth in downside stock put option premiums that occurs when option buyers and sellers anticipate sharp a downward move.
Therefore a very low volatile VIX index is often interpreted as a sign of a market waiting before a significant decline.
The graph below shows a VIX at a record low. The previous low was in 2007 before the sharp decline of 2009.
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