Wednesday, October 17th, 2018

VIX Related Stock Gains

 

Forecasters have been talking of late about VIX related stock gains. The Chicago Board Exchange Market Volatility Index (VIX) has risen to historic highs in response to the ongoing drama of the European debt crisis. The VIX is a measure of market volatility. It is a reflection of the options market’s expectation of movement of S&P 500 stock over the coming month. VIX related stock gains have happened frequently in the two decades that the VIX has been in existence. When the VIX has remained above 40 for a month it has tended to be followed by S&P 500 gains in the following month and in the following year. How to trade stock options successfully includes learning the cues that predict movement. The VIX does not look specifically at investment opportunity in stocks like Boeing – BA – and the sale of its first 787. VIX related stock gains are an occasional occurrence. An extremely high VIX is commonly referred to as the fear index. The Market Volatility Index is simply a measure of market expectation of price movement. When the market has fallen in response to past events it is often an indicator of a market turnaround.

The VIX is weighted measure of options on the S&P 500 index. It measures out of the money calls and puts. The VIX uses a mathematical formula to produce its number. Many traders are just as happy measuring simple past volatility as in using the VIX to predict future options and stock prices. An interesting comparison to VIX related stock gains is one of the Japanese Candlesticks, the Doji. This easy to read set of symbols has been in use for centuries, having had its origin in rice trading in ancient Japan. The Doji candlestick is vanishingly short with long upper and lower shadows. This signal tells us that the equity involved opened and closed at nearly the same price but that it traded substantially higher and lower during the trading period measured. It is considered a measure of market indecision and typically precedes a market turnaround. In this sense it is like the VIX which indicates volatility but not necessarily the direction in which options or stocks will move. A large part of options trading education is, in fact, to learn to use these tools effectively and profitably.

The current issue occupying the options market is the state of European debt crisis. Interestingly only a small percentage of US exports go to Europe and US banks are said to have little exposure to the national debts of the five PIIGS nations (Portugal, Ireland, Italy, Greece, and Spain). Nevertheless the ongoing drama across the Atlantic seems to be impeding an otherwise promising US recovery as companies hold off on investments due to uncertainty about the global financial situation. The stock market has lost ground in big swings and sentiment has become bearish. A number of analysts are making the point that when virtually everyone thinks the market is bad that it is time for the market to turn around. This sentiment is in line with the history of VIX related stocks gains after the VIX hits historic highs. A reasonable way to interpret a really high VIX is that the market has overshot on its way down, due to individual investor and trader panic. Memories of the 2008 crash are fresh and no one wants to get burned again. However, there comes a point when stocks are woefully undervalued and it is time to buy. Those who believe that the market is set to rally can take advantage of options trading leverage and buy calls with the possibility of substantial profits if the market produces VIX related stock gains. As always we are not suggesting trading the S&P 500 or any particular stock or option. Rather we suggest that options traders learn to use and consider all market indicators when trading.

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