The Plunging VIX

Do you realize that it’s been nearly two years since we’ve had a 2% move on the S&P 500? That’s the longest streak since the mid-90s. With so little action out there, the day-traders must be pulling their hair out!

Volatility is closely watched on Wall Street. Many options investors ignore stocks all together and solely play volatility. The Chicago Board Options Exchange has its own volatility index, which is better known as the VIX. Real estate and oil may be bubbles, but the VIX is in the clutches of a ferocious bear. Today, the VIX closed at 10.36, which is just above an 11-year low.

We used to have wild moves all the time. There were 41 days of 2% or more moves from July to November of 2002. That’s about two a week. Back then, the VIX soared above 40. But not anymore. We haven’t even had a 1.2% day in nearly three months. There’s just no volatility out there.

What does it all mean? It’s hard to say. Volatility is often misunderstood. It’s not necessarily a bad thing to have rising volatility. The media loves to wag its finger at an erratic market, but there isn’t a strong correlation between current volatility and future return. There’s a slight—and I mean very slight—relationship between rising volatility and a turn in the market. But it’s too small to be a viable indicator.

The market started becoming more erratic in mid-1985, but was actually cooling off just before the crash in October 1987. Rising volatility did coincide with bull market of the late-90s. But volatility stayed high through the market crash, and it didn’t start calming down until the market hit rock bottom in October 2002.

If anything, volatility represents how “content” the market is right now. That’s unlikely to change until events change. As long as volatility is falling, the market is happy to continue doing what it’s doing.

Posted by on July 27th, 2005 at 6:15 pm

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