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!