Thursday, December 17, 2009

Volatility/VIX

one of the behavioral finance ideas about mistakes people make says that most investors mindsets are skewed by recent history -- they lose perspective and will often extrapolate recent experience into the future regardless of whether that makes sense or not. Consider the VIX and Rosenberg's comments about it. In fairness to him he is an economist not an options person.

but he recently made comments about the VIX spending a lot of time next year between 30 and 40. The problem is that makes no sense unless you expect sharp declines and a huge increase in the volatility of the market -- i.e. daily up and down moves north of 2%. A VIX of 21 is very close to its lifetime average so insurance is not cheap.

historical volatility is running significantly less than implied volatility so the VIX is currently most likely overpriced by several percent in terms of what the actual volatility will be in the next 30 days. in other words to justify the current level of the VIX we need to see a sharp increase in volatility. what is even more strange is the VIX futures were recently at a 4 point premium to the cash VIX -- so the difference between the VIX futures and recent actual volatility is at least 10 percentage points. wow.

I figure as long as that volatility premium is in place or folks are talking about a VIX of 21 as saying there are cheap puts available, its bullish for the markets.

that said, I'm not sure I expect the move to 1250 by mid january that was written up in Barron's this last weekend. I've also seen the end is here type of writing -- Kass went "all in" on his short position this week -- huh? is it really that bad right now that all in short is the right posture. he did this wednesday so Thursday's decline is great but he didn't say anything about covering shorts so I assume he ended today still all in. wow.

Also read a lot of comments about consolidations or tight ranges end with the prior trend in place -- i.e. everyone expects the market to break out its just a matter of time. then Thursday's decline hit -- perhaps that changed enough minds but chances are most still believe it. yes I do too but I'm not in any hurry either --

I am starting to think we will simply widen the range up and down rather than break out. so add 25-50 points on to each end and that is what I'm thinking about (say from 1025 to 1170). that way we can stay within a range for that much longer and frustrate as many market players as possible.

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