Monday, May 01, 2006

Flat Market, Rising VIX: What Happens Next?

In the past three trading sessions, the S&P 500 Index (ETF) has been flat, while the VIX measure of option volatility has risen by over 6%. So I decided to look at what typically happens when fear has entered the marketplace during a period of relatively flat prices.

Since March, 2003 (N = 795), we've had 101 sessions in which SPY has been up or down within a range of .20% from its previous day's close. When the flat SPY day has occurred during a rising VIX (N = 50), the next three days in SPY have averaged a gain of .18% (29 up, 21 down). When the flat SPY day has occurred during a falling VIX (N = 51), the next three days in SPY have averaged a decline of -.12% (22 up, 29 down).

It appears that, in this context, fear--which generates increased option volatility--is more bullish for the market's short-term performance than complacency. Perhaps Mr. Bernanke was doing the market a favor, after all.