Best of the Week
Most Popular
1. US Housing Market House Prices Bull Market Trend Current State - Nadeem_Walayat
2.Gold and Silver End of Week Technical, CoT and Fundamental Status - Gary_Tanashian
3.Stock Market Dow Trend Forecast - April Update - Nadeem_Walayat
4.When Will the Stock Market’s Rally Stop? - Troy_Bombardia
5.Russia and China Intend to Drain the West of Its Gold - MoneyMetals
6.BAIDU (BIDU) - Top 10 Artificial Intelligence Stocks Investing To Profit from AI Mega-trend - Nadeem_Walayat
7.Stop Feeding the Chinese Empire - ‘Belt and Road’ Trojan Horse - Richard_Mills
8.Stock Market US China Trade War Panic! Trend Forecast May 2019 Update - Nadeem_Walayat
9.US China Trade Impasse Threatens US Lithium, Rare Earth Imports - Richard_Mills
10.How to Invest in AI Stocks to Profit from the Machine Intelligence Mega-trend - Nadeem_Walayat
Last 7 days
Brexit Party and Lib-Dems Pull Further Away from Labour and Tories in Latest Opinion Polls - 22nd May 19
The Deep State vs Donald Trump - US vs Them Part 2 - 21st May 19
Deep State & Financial Powers Worry about Alternative Currencies - 21st May 19
Gold’s Exciting Boredom - 21st May 19
Trade War Fears Again, Will Stocks Resume the Downtrend? - 21st May 19
Buffett Mistake Costs Him $4.3 Billion This Year—Here’s What Every Investor Can Learn from It - 21st May 19
Dow Stock Market Trend Forecast 2019 May Update - Video - 20th May 19
A Brief History of Financial Entropy - 20th May 19
Gold, MMT, Fiat Money Inflation In France - 20th May 19
WAR - Us versus Them Narrative - 20th May 19
US - Iran War Safe-haven Reasons to Own Gold - 20th May 19
How long does Google have to reference a website? - 20th May 19
Tory Leadership Contest - Will Michael Gove Stab Boris Johnson in the Back Again? - 19th May 19
Stock Market Counter-trend Rally - 19th May 19
Will Stock Market “Sell in May, Go Away” Lead to a Correction… or a Crash? - 19th May 19
US vs. Global Stocks Sector Rotation – What Next? Part 1 - 19th May 19
BrExit Party EarthQuake Could Win it 150 MP's at Next UK General Election! - 18th May 19
Dow Stock Market Trend Forecast 2019 May Update - 18th May 19
US Economy to Die a Traditional Death… Inflation Is Going to Move Higher - 18th May 19
Trump’s Trade War Is Good for These 3 Dividend Stocks - 18th May 19
GDX Gold Mining Stocks Fundamentals Update - 17th May 19
Stock Markets Rally Hard – Is The Volatility Move Over? - 17th May 19
The Use of Technical Analysis for Forex Traders - 17th May 19
Brexit Party Set to Storm EU Parliament Elections - Seats Forecast - 17th May 19
Is the Trade War a Catalyst for Gold? - 17th May 19
This Is a Recession Indicator No One Is Talking About—and It’s Flashing Red - 17th May 19
War! Good or Bad for Stocks? - 17th May 19
How Many Seats Will Brexit Party Win - EU Parliament Elections Forecast 2019 - 16th May 19
It’s Not Technology but the Fed That Is Taking Away Jobs - 16th May 19
Learn to Protect your Forex Trading Capital - 16th May 19
Gold Ratio Charts Offer The Keys to the Bull Market - 16th May 19
Is Someone Secretly Smashing the Stock Market at Night? - 16th May 19

Market Oracle FREE Newsletter

U.S. House Prices Analysis and Trend Forecast 2019 to 2021

Beyond The Stock Market VIX Volatility Index

Stock-Markets / Volatility Apr 21, 2011 - 02:32 AM GMT

By: Tony_Pallotta

Stock-Markets

Best Financial Markets Analysis ArticleI have traded options for a number of years and fully understand the "greeks" as should any active options trader. When you understand options you realize how valuable of a tool they are for investing, managing risk and understanding market sentiment. They are not as risky as many think. Before I share a rather important chart, I think it is important to go over a few option basics to fully appreciate what the data is telling you.


Implied volatility (IV) is one of the most important elements of how an option is priced. The simplest analogy is that of supply and demand. When traders are buying a specific option they drive the IV higher. When they are selling they drive it lower. The technical answer is based on a theoretical pricing model like black scholes, IV is the value needed to equate to a given price.

Ahead of company earnings for example, investors buy puts or calls causing the IV to rise. Once earnings are over, IV falls and so does the price of the options. Stay with me here and I promise to keep it as simple as possible. IV varies across time and strike price and is not linear, in fact if you graphed the IV for various strike prices you would see a "smile." This smile though is not uniform and in fact shifted more towards puts and less towards calls.

The chart below shows such an "IV smile" both pre 87 crash and post. Notice how volatility is higher for puts (left side of the curve) and lower for calls (right side). The more fearful investors are the more they buy puts and less they buy calls. The result puts generally have a higher IV than calls.

The VIX is the widely used measure of fear in the market as it measures implied volatility on the S&P 500. The lower the number the less fear, the higher the more fear. The CBOE though realized that the VIX does not capture the true picture of fear and or complacency in the market. Since the 1987 crash, investors have realized there is a risk of another crash and buy further out of the money options. In 1990 the CBOE created the CBOE Skew index which specifically measures these tail risks and how investors are pricing them in.

That's the class, now the chart. Below is a chart of the Skew Index VS the VIX from January 2008 to present.

Notice how since the March 2009, the Skew Index has actually risen while the VIX has fallen. The VIX has really given a false sense of security.

More importantly notice the two green boxes. The first is the flash crash of 2010. Notice how the VIX makes new lows while the Skew index makes new highs. Then once the market place reacts to falling asset prices, the VIX rises while the Skew Index falls. Now look at the next green box. The same exact divergence is occurring. Last month's selloff is even reflected.

The VIX is flashing a bullish divergence right now with the daily MACD which combined with the above chart should send chills down anyone who is overly leveraged and long this market right now.

If all was well, why would professional traders be speculating in out of the money options versus retail traders who based on the current VIX level are very complacent and have little to no insurance on their longs.

By Tony Pallotta

http://macrostory.com/

Bio: A Boston native, I now live in Denver, Colorado with my wife and two little girls. I trade for a living and primarily focus on options. I love selling theta and vega and taking the other side of a trade. I have a solid technical analysis background but much prefer the macro trade. Being able to combine both skills and an understanding of my "emotional capital" has helped me in my career.

© 2011 Copyright  Tony Pallotta - Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules