Saturday, July 08, 2006

QQV: NASDAQ Option Volatility and Short-Term Returns

The QQV is a measure of the implied volatility of a hypothetical at-the-money QQQQ (NASDAQ 100 Index) option, expressed as an annual standard deviation of returns. It is intended as a measure of trader sentiment regarding future volatility of the Index. Like the better known VIX, QQV tends to rise in falling markets and fall in rising markets.

Since 2004 (N = 623 trading days), when QQV has made a 10-day low (N = 102), the next five days in QQQQ have averaged a loss of -.14% (49 up, 53 down). That is worse than the average five-day gain in QQQQ of .08% (271 up, 250 down) for the remainder of the sample.

On the other hand, when QQV has made a 10-day high (N = 87), the next five days in QQQQ have averaged a sizable gain of .48% (55 up, 32 down). That is much stronger than the average five-day loss in QQQQ of -.03% (265 up, 271 down).

It appears that when traders are feeling safest--i.e., expecting the least volatility--returns are subnormal in the NASDAQ. When traders are expecting the greatest turmoil, returns are superior. Perhaps there really is opportunity in crisis!


Denver_Investor said...

Brett..How are you defining a 10 day high?

Are you using end of the day numbers only, or does an intraday high higher than any reading the previous 10 days qualify?

thanks..interesting stuff

Brett Steenbarger, Ph.D. said...

Hi Denver Investor,

Good question; my bad. I'm using intraday highs and lows in QQV to define the highest highs of 10 days and the lowest lows. I suspect using closing data would yield similar results, but have not tested this.


John Wheatcroft said...

I just ran a very quick and dirty eyeball study of this theory across 200 days of INDU data vs the VIX using the close. My findings support yours and suggest further study is required.

I think this might be a good indicator. I'll be setting it up in my model and watching it for awhile. Thanks.

Brett Steenbarger, Ph.D. said...

Thanks, John. It will be important to test the idea across a variety of market conditions: bear, as well as bull.