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Options Expert: Vix Rally is NOT Capitulation

From Andrew Wilkinson of Interactive Brokers:

Typically seen as a contrarian indicator the VIX, also known as the fear gauge, rose to its highest reading in about six years this week when it peaked at 59.06. The index uses option prices of calls and puts on S&P 500 index components and is a measure of the premium demanded by option sellers.

Because option implied volatility is a key component of option prices, the higher the premium demanded for both calls and puts, the higher the calculation of VIX. When the VIX spikes in times of greatest uncertainty, investors often use this as a signal for an "all-clear," to reenter the market in the short term at least. Until recently, equity investors identified such spikes at readings of between 30-40, which are clear to view on a chart when they occurred in January, March and July this year.

However, the snowball of fear that has set off an avalanche of collapsing financial institutions has created an altogether new regime for volatility. The traffic in the VIX has been one-way for the past three weeks and the minimum reading since the SEC’s ban on short sales was 30.81. Since that time the S&P 500 index has cratered by 22% as confidence erodes and fear grows.

It’s extremely difficult to see which, if any, of the recent measures from either government departments or central banks is sufficient catalyst to turn investor sentiment positive on a lasting basis. The largest equity market in the world is going through a humbling period and is working off excesses, which have been building throughout the duration of the homebuilding boom. It appears that even a demanding 24/7 work schedule from the U.S. authorities isn’t providing the required respite as the problem migrates from one of house prices in freefall to outright lack of confidence in banks.

It would take a brave soul to interpret the recent rally in the VIX as a capitulation point for the workout of corporate and consumer excess.

Track the Vix here ...

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Andrew Wilkinson is the senior market analyst at Interactive Brokers Group, where he provides daily commentary and analysis on U.S. equity options trading throughout the trading day. Andrew provides webinars designed to explain option-related trading scenarios covering futures, fixed income, forex and equities.