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