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Option Watch: The VIX's Mean Reversion?

By Chris Tyler, Optionetics.com | Mon March 12, 2012 9:57PM PT


On the eve of the NCAA’s March Madness basketball tournament, a similar game of comebacks, exhilarating offensive and defensive play and even last second buzzer style wins have been spied in the broader market over the first several trading sessions of March.

In Monday’s session, despite a very tight inside candle in the SP-500 and gainer by the narrowest of margins of just 0.09%, investors managed to pull off an upset of sorts in knocking the CBOE Volatility Index($VIX) down 8.59% from Friday’s 17.11% close to 15.64%. The action, in conjunction with its intraday low of 15.23% managed not only to strike fresh lows for 2012 but also for all intents and purposes, tested key support for the past couple years.

Some might suggest the confident behavior is simply a reflection of lesser market volatility. In fact, it is, as the SP-500 (SPY) actually trades around 10% statistical volatility if one looks at its 10 and 20 day readings. Thus, from that vantage point, implieds in the VIX still show some appreciation for risk. And after last year’s extended period of abnormally elevated volatility from August through November, shouldn’t it be time for some drawn-out payback, with premium sellers allowed to dominate the action beyond what might appear to be reasonable?

In recognizing the sentiment gauge is a mean-reverting instrument and cognizant a Buzz Lightyear “To infinity and beyond!” won’t be happening in our lifetimes, nor for that matter 0.00%, we can appreciate investors ability to grow more confident as Europe’s credit crisis, the one largely responsible for the explosion in market volatility, draws to a simmer from boiling-like conditions.


Figure 1: CBOE Volatility Index ($VIX) Weekly

At the same time, we’re also fans of bulls managing to climb a wall of worry in the broader market and confidently sell premium protection in the face of newer risks like Iran, despite popular folklore of the market hating uncertainty. What’s more, while our weekly view doesn’t show it in Figure 1, there have been lengthy stretches when the VIX traded near and even into the high single digits. The last such bout occurred not so long ago during 2004 – 2006; though that may seem like a surreal American dream of sorts.    

I suppose our only real problem with Monday’s test of support in the VIX, other than it being strong-looking support as annotated above, is the differential or spread in excess of 15% with the instrument’s 10SMA. In the end, if the broader market is going to move confidently forward, it’s unlikely to do so with the greatest of ease given those two minor details and despite more yummy Apple (AAPL) delights likely being served. That said, the mean in mean reversion could take on a bit of added significance for bulls than in recent days, weeks and months--and hence, make less popular (these days) protective strategies such as married puts or collars, more than just good food for thought.

 

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
Optionetics.com ~ Your Options Education Site
Visit Chris Tyler’s Forum
 
The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual. 

 



Recent articles by Chris Tyler, Optionetics.com


September 21, 2012  -  Wall Street's Friday Lunch Options
September 21, 2012  -  Hot Shots: All Aboard or Train Wreck?
September 20, 2012  -  Wall Street's Thursday Lunch Options
September 19, 2012  -  The Expected Move: Bed Bath & Beyond Earnings
September 19, 2012  -  Wall Street's Wednesday Lunch Options


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