Thursday, January 17, 2008

Weak Market, Weak VIX: What It Might Mean

A number of market commentators have observed the relative lack of action of the VIX during the recent falling market. Normally, in a declining market, we see a rise in the VIX. That indicates higher options premiums and often is interpreted as a sign of fear in the marketplace. So what does it mean when we have a falling market, but the VIX actually declines during that time?

Over the past ten trading sessions, we've dropped nearly 6% in the NYSE Composite Index. During that same period, the VIX has declined a bit more than 1%. I went back to the start of 2000 (N = 2012 trading days) and could not find a single other instance of a VIX dropping during a ten-day period in which stocks were down more than 5%. That suggests that the current action of the VIX truly is unique (which, of course, makes it difficult to interpret).

I went back to 2000 and identified all 10-day periods in which the NYSE Composite Index ($NYA) was down more than 4% and less than 7% (N = 110). The average VIX change during those periods was +26.6%. I then performed a median split, examining what happens ten days following relative small vs. relative large VIX moves during those falling periods in stocks.

When the VIX move was below average (N = 55), the next 10 days in $NYA averaged a loss of -.23% (23 up, 32 down). When the VIX move was above average (N = 55), the next 10 days in $NYA averaged a gain of .24% (31 up, 24 down).

What this suggests is that declines accompanied by relatively little fear have been more likely to continue their downward course than declines accompanied by a large expansion in the VIX. Note also, per my recent post, that we're also not seeing extreme levels of bearishness in the equity put/call ratio during the selling this week.

Is the market pricing in a Fed rescue? Is the market priced for perfection? These are the questions I'm mulling in light of the current action in the VIX.


How VIX and Put/Call Ratio are Related

The Volatility of the VIX


trndman said...

Quiet VIX equals Stealth Buying?

Using three indicators, On Balance Volume (OBV), Chaikin Oscillator, and MoneyFlow (MF), I have noticed significant divergences in a few products. Viewing weekly, daily, & 60min. charts of the Euro one can see the transformation of this disparity, price going up while indicators go down. Monday presented a 'gap up' (depending on your trade times), though the lid was maintained on OBV and Chaikin (daily charts). MF went into "overbot". Tuesday, 1/15, showed another push up in price only to follow with a drop in the 11am hour. Wednesday the 'truth', as I like to call it, was shown and the fruit to the indicators was produced with a nasty sell-off to the Euro.
Interestingly, a similar scenario is occuring with crude oil. Again, viewing the different time frames: weekly, daily, and 60 or 45min charts with the three indicators show parallel transformations to the Euro. MF typically sends the first flag, followed by the other two, OBV and Chaikin. Harmony must be sought when considering the different timeframes.
So what does this have to to with the VIX? Every morning for the past 4 weeks or so I wake up and I get a "morning call" from the OBV indicator. On the $INDU daily chart the message reads: "Bullish divergence - new low not confirmed". Upon further review I see OBV continuing to trend up as the index continues to fall. I term this situation as "convergence", rather than "divergence". Yesterday, MF moved into 'oversold' for $INDU daily. Some say that the Dow is the last to sell-off in the bear markets. Perhaps this concurs your view of the large caps not being pulled down as much in recent trading sessions? So, in view of expansion new 52-week lows vs. highs and decreasing A/D lines, along with a quiet VIX could "Stealth-Buying" be occuring?

Glen Bowman, Ph.D. said...

The higher the VIX, the higher UPSIDE potential (VIX is not simply an index of fear; it is also an index of greed).

A low VIX in a declining environment might suggest that the inevitable rally will not be that impressive, and that we may well be in a bear market, complete with lower highs and lower lows.

Brett Steenbarger, Ph.D. said...

Thanks for the excellent insight, Glen!