Friday, September 01, 2006

How Much Opportunity is in the Market?

In my post for today's Trading Psychology Weblog, I took a look at 40-day segments of the S&P 500 Index market going back to 1990 and found that there was a dramatic difference in the size of the market's expectable movement as a function of the current day's VIX, its options volatility reading. When the VIX was high, the median move size in SPX over 40 days was three times as great as when the VIX was low.

This appears to be the case for daily and weekly data as well. How much potential opportunity in the market there is--its total amount of offered movement--correlates quite well with the volatility priced into the index options.

Going back to 1990 (N = 4204 trading days), we have 287 occasions in which the daily VIX was greater than 30. The median daily high-low range on those occasions was 2.275%, and the median size of the daily move (from yesterday's close to today's close) was 1.21%.

When VIX was between 25 and 29.99 (N = 432), the median range (daily change) was 1.75% (.95%). A VIX between 20 and 24.99 (N = 940) gave us 1.32% (.67%), whereas a VIX between 15 and 19.99 (N = 1225) provided .97% (.49%). That tells us that a VIX between 15 and 20 has given us about half the movement of a market with a VIX above 25.

What happens when VIX drops below 15, as is the case at present?

When VIX has been between 12.5 and 14.99 (N = 729), the median range (daily change) has been .74% (.34%). Those numbers drop to .63% (.31%) when the VIX is below 12.5 (N = 591). In all, there is nearly four times as much movement in a high VIX market as a low one. A market such as we had in June, in which VIX rose above 20, has twice the movement of the present market.

Bottom line? Not all movement is opportunity, but you can't have opportunity without movement. Since June, opportunity has been cut in half for daytraders of the S&P market. Imagine if basketball players one season found the rims set for a height of 10 feet, then 12 feet the next season and 9 the one after that. Suppose the pitching mound in June was 59 feet from home plate, but 40 in August.

That is the challenge of being an equity index daytrader.