Monday, May 25th, 2020

VIX Frenzy

 

According to Bloomberg a 30 minute VIX frenzy exposes obsession with volatility hedging. What is that all about?

Among the many scary things traders witnessed as stocks plunged last Monday, one of the most harrowing was the sight of the VIX, an index designed to measure investor fear, briefly going dark.

For almost 30 minutes as hundreds of billions of dollars were erased from equities, no signals were sent by the world’s most popular sentiment gauge as options prices turned erratic. When it switched on, the VIX jerked higher faster than anyone had ever seen, rising 82 percent on its first tick to 51, a level not reached since the financial crisis.

“Seeing the VIX at 50 was just chaotic,” said Michael Antonelli, an institutional equity sales trader and managing director at Robert W. Baird & Co. in Milwaukee. “It’s not like there was a headline that a bank had filed for bankruptcy or a major corporation was teetering on the brink. Why did it move that much?”

Nothing could’ve kept the Chicago Board Options Exchange Volatility Index from jumping Monday morning: global markets were buckling, China’s stocks had plunged 8 percent and companies like General Electric Co. were in free fall.

The origins of the VIX frenzy are in Asia. China is finally coming clean about its slowing economy. It stock market has tanked. Investors expect to see a generally slowing global economy with no clean idea about just how far things will fall.

Global Growth Fears

Reuters notes that global growth fears are sending US stocks downward.

[W]eak data from China intensified fears that a stumble in the world’s second-largest economy will hobble global growth.

China and the world have become accustomed to ten percent or better economic expansion in China. However, this large economy has limited to its growth based on exports as the world has a finite capacity for products made in China. China needs to convert to a consumer driven economy and needs to loosen up on its control. This means closing state owned factories that are losing money and letting the families of Communist Party leader who are raking in profits start losing money and pay their debts. Even the Chinese are starting to see the similarity between Japan at the end of the 1980s and China now. Japan went into a quarter century of deflation. A large part of the VIX frenzy is that options traders suspect that this may be China’s fate as well. When China quits importing so much iron ore, coal, oil and other raw materials countries from Australia to Brazil suffer. The fall in US stocks and VIX frenzy comes from fears that the effects of the Chinese economic slowdown will be felt globally and for a long time.

How Can I Use the VIX?

The Chicago Board Options Exchange (CBOE) defines VIX options.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility. Several investors expressed interest in trading instruments related to the market’s expectation of future volatility, and so VIX futures were introduced in 2004, and VIX options were introduced in 2006.

Options and futures on volatility indexes are available for investors who wish to explore the use of instruments that might have the potential to diversify portfolios in times of market stress.

While the VIX is a measure of fear and uncertainty in the stock market, traders can trade options on the VIX itself. This approach can be used to hedge risk or to seek profits at a time of intense VIX frenzy.

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