Wednesday, August 3, 2011

Non-Volatile Volatility

Something interesting is happening.  Normally, the stock market falls when volatility increases or vice versa. It is not uncommon for investors to buy the volatility index (VIX), which would go up when the market goes down.  But, that longtime relationship is not working right now, why?

One thought is that the VIX moves quickly during the day, while most "hedge" buyers have VIXM, which has a longer time frame, creating a mis-match in time.

Technically, the VIX measures the price people pay for options to protect their portfolios, e.g., buying a put to sell the S&P or put it to the seller if the market crashes.  Another thought is that so many people have left the market for the sidelines that nobody needs to buy portfolio protection, causing the price of options to decrease.

The most interesting thought is that the sell-off is caused by retail investors leaving the market.  The VIX is primarily used by more sophisticated investors, who don't feel they need it now, because they have turned bullish.

If the retail investors are in a panic leaving the market, while the "smart money" is turning bullish, there may be a very important signal here.  I'm studying . . .