The VIX has crumbled today, down to 23.30 (-9%) as of print. 23. That’s not indicative of much fear. Is a VIX print of 23 predictive of an unpcoming market rally or misrepresentative of the current atmosphere?
As I’ve said before, VIX measures “fear” using a calculation of option premia on singlename equities. For example, VIX extracts the premium paid by an investor who bought a long put (or sell-short call) on GE common stock–usually a hedge for a long position on the underlying stock. I repeat: VIX is very much a coincident indicator and increasingly a reflection of the “dumb [retail] money”:
I’ve always held that the VIX is an inaccurate gauge of volatility. Philosophically, I’d have to ascribe that to the reflexive feedback loop wrought from its mainstream acceptance. I often opt for Implied Correlation (KCJ), but even that has gained wider acceptance and therefore eroded predictive powers.
(Remember that: “I often opt for Implied Correlation.”) I see LIBOR surging ahead unopposed. I see Eurodollar Swap Futures fading the global, coordinated Central Bank intervention. I see EURUSD collapsing. I saw overwhelming demand at last week’s 3-year US T-Bill auction. These points all indicate a crowding out of EUR into USD, of which there’s apparently a severe shortage–despite the Fed’s generous swap lines.
Nevertheless SPX 1232, VIX 23. To the retail investor, markets are like that duck from the old adage: calm to the onlooker’s eye, but treading furiously underwater to stay afloat.
VIX at 23 is a real dislocation in my eyes–far more out of sync than even SPX 1232. I can’t get over that. I had to look at other fear gauges to find confirmation of VIX’s plea, and there’s where I found the stress. Unlike VIX’s utilization of singlename options, Implied Correlation (ICJ) uses the option premium on index options. In other words, when institutional traders want to hedge SPX–not just GE–they use ICJ. The divergence between Implied Correlation & VIX is unprecedented as of today. In fact, the spread between the indices has levitated to an alltime high:
I’d be amiss to not acknowledge the spread spike in October 2010, which was proximately met by a SPX rally. However, I maintain that today’s US markets will remain in want of additional stimulus until Europe’s problems are settled.
I’d suggest that neither index had predictive powers, nor do the traders who utilize them. However, they all provide context, which suggests substantial risks remain, although the duck seems to be relaxedly going with the flow. The question remains where & when the risk will manifest, to wit I don’t expect anything before Christmas. In a brilliant alignment of technicals & fundamentals:
- The next
reckoninghurdle arrives with Greek bond maturities on December 29 & 30–€5.23B & €715M respectively.
- VXX & VXZ divergence suggests more intermediate-term (VXZ) anxiety than front-month (VXX) in a kind of volatility curve contango.*
- I notice a short-term Bull Pennant/Cup & Handle has developed in SPX, the inverse of which EURUSD leads by about two trading days.
- SPX also exhibits a neat bull Head & Shoulders, with neckline around 1270.
The latter two points are exhibited below:
–Romeo (*hattip Jeff Norman)