At first glance this seems counter intuitive; earnings are often the most active periods for stocks. How can premiums for 30 option hedges be getting cheaper? To me the answer is found in the concept of correlation of stock returns. Correlation basically is the measure of how stocks move in relation to one another. If stock XYZ is down, in a highly correlated market, stock ABC will also likely be lower. During times of macro market crisis, stocks would tend to move in concert. The level of correlation in the market place during 2008 reached historically high levels. During this time we also saw the VIX spike to unprecedented levels.
Currently, however, and perhaps even more so during earnings season, the market is seeing a mix of winners and losers as companies announce their earnings. This variety of movement is more normal market behavior. Realized correlation has experienced a steady drop and is now closer to its historical average of below 0.40. The shorter dated implied correlation has also dropped from its elevated levels and if the market continues to trade in a more “normal” fashion, I would expect the VIX to continue to remain at levels that may appear cheap.
However, in trying to determine if the lower VIX indicates a time to buy there is another consideration. The implied volatility curve is positively sloped. This is apparent in the VIX futures that are trading at higher levels in December (VXZ 25.20%) and January (VXF0 26.25%). So, if the VIX index doesn’t increase as we approach the end of the year, it is actually decreasing from where it is predicted currently.
If you believe the market will continue to move toward normalcy in trading patterns, the lower VIX would not necessarily be an indication that it is time to buy. If you think our recovery is doomed to fail however, the lower implied volatilities we are seeing may appear to be a bargain.
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OK. First of all what is VIX ? Is it Chicago Options CBOE VOLATILITY INDEX ? I had to look this up :-) . VIX is such an abstract thing since it is basically a derivative of the derivative on a bunch of stocks … After looking at VIX chart all I could say is when Dow and Nasdaq are going up VIX is going down and vice versa.
Today was an awesome day with a fun ride ! Especially at the end. I had a bunch of orders on stock option calls and all of a sudden at the end of the day they all started to execute like crazy… I hope tomorrow we will go back up ! If not just have to buy more :-) That gives you something to do. I enjoy buying stock option calls since my computer takes me on a amazing excursion of truly incredible earnings opportunities.