VIX Index VIX Index: Film Noir
by Eric J. Fry
The Rude Awakening
Wall Street, New York
Thursday, April 6, 2006 Eric Fry notes the new index option on the VIX Index from the Chicago Board Options Exchange. ------------------------- - What plot twists lay ahead for our temporarily
tranquil markets?
- How to "buy volatility" when things go awry and,
- Gold and silver up again...have you got yours? All
the market data and two more things...
------------------------- [Joel's Note: Just before we get into Eric's epic, tear-
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http://www.agora-inc.com/reports/OST/EOSTG438 -------------------------- Eric Fry, reporting from San Francisco... "If your love life were a feature film," your editor asked
a French friend yesterday, "what film would it be?" "Hmmm...je ne sais pas," she replied. "Sure you do," I insisted, "or at least you know what genre
it would not be. For example, would it be a horror film?" "I don't think so," she laughed, "Maybe it would be more
like a black and white documentary." "So your love life is an indie film?" I suggested. "That's
so French...with sub-titles, right?" "Mais oui!...What about you? I suppose you will tell me
that your love life is a big-budget American action flick." "No, but thanks for the compliment," I smiled. "Then what is it?...A silent film?" "That's harsh...No, it would be a 'talkie,' at least...In
fact, it would be an epic." "Oh please!" the French friend protested, "You flatter
yourself." "Isn't that the point of this exercise?...But maybe you're
right. So I'll confess that my love life is not an epic;
it's a big-screen musical...with a 'G' rating." "Uh huh, right," she smirks. "I was thinking of a musical like the King and I." "Really?" the French friend replies, "I was thinking of Les
Miserables!" "Revolutionary? Is that what you mean?" I asked innocently. "Not exactly." "You know," I continued, "There are so many possibilities.
A love life could resemble slapstick comedy...or
melodrama...or science fiction..." "In an age of Viagra and breast implants, every love life
is science fiction, n'est-ce pas?"
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Film Noir
By Eric J. Fry If today's stock market were a feature film, it would be a
light-hearted romantic comedy. Warm smiles and laughter
would arrive frequently and predictably. And even during
those moments when the central characters might encounter
short-term disappointments, the film's happy ending would
never be in doubt. But today's stock market is not a feature film; it is a
vast repository of hard financial data and soft human
emotions. At extremes, human emotion counts more than hard
data. As investor sentiment oscillates between extremes of
greed or fear, share prices soar...or sink. Lately, stocks
have been soaring, both here at home and abroad. As a
result, most measures of investor sentiment are registering
high levels of confidence and complacency – the very
attributes that often presage important market peaks. VIX Index: A New Series of Options Investors who fear the near-term fate of the U.S. stock
market, therefore, may avail themselves of a new index
option from the Chicago Board Options Exchange. A few weeks
back, the CBOE issued a new series of options on the VIX
Index. (This index is also known as the "fear gauge." To
learn more about it and the new VIX options, click here:
www.cboe.com/micro/vix/introduction.aspx). These options
provide a very novel way to hedge against an overdue stock
market correction. More than two years have elapsed since the last time the
S&P 500 slipped more than 10%. Such tranquility has
fostered widespread complacency, as evidenced by the VIX
Index itself. At a reading of 11.13, the VIX languishes
very near its all-time low. In other words, investor fear
is near an all-time low. For perspective, the VIX ticked
above 14 as recently as January, and soared above 40 twice
in the last 5 years. In other words, 11.13 is quite low
indeed. An anxious investor, therefore, could purchase call
options on the VIX and hope for a meaningful stock market
correction. The low VIX reading is not the only hint of investor
exuberance. Several global equity indices provide
additional hints: The Nasdaq's 5-year high, the Russell
2000's all-time high, the Russian stock market's all-time
high, the Indian stock market's all-time high and the
rapidly expanding population of all-time highs elsewhere
around the globe. Back here at home, bullish sentiment has approached rare
extremes. "The 10-day Daily Sentiment Index (MBH Commodity
Advisors) last week hit a sky high 86.6% Bulls," notes
options pro, Jay Shartsis. "In the near 20-year history of
this survey, only eight days have reached a greater bullish
extreme. This is a good piece of bearish evidence." VIX Index: Divergence and What It Means Adding to the growing body of bearish indicators, Shartsis
notes, "Over the past six months, the Dow Jones Utility
Average is down 10%, while the broad market has been
rising. What does this divergence mean for the coming days?
One study looks at past experiences when the utilities were
down at least 10% over a six-month period while the S&P 500
was up at least 5% over that time span. Going back to 1950,
there were only five such occurrences and the performance
of stocks subsequently was quite negative. Over the
following three months, the S&P 500 lost on average 8.4 %
(from Sentimentrader.com). That is an eye opener. "The crash in 1987 was preceded by one of these divergences
as was the grand top of March 2000. These divergences carry
on for what seems like a long time to people who watch the
market every day. The broad market just soldiers on and it
doesn't seem to matter, until the day comes when it does
matter." Perhaps that day is fast approaching. Many of the world's
equity markets are priced for perfection...and most
investors seem to anticipate continuing perfection. We do not. But neither do we anticipate extreme imperfection. We
merely observe that U.S. share prices are relatively high
and that the VIX Index is relatively low. Therefore, the
price of betting on imperfection has rarely been lower. An
August 15.00 call option on the VIX Index costs about
$1.25. That's not exactly cheap. But neither does it seem
so expensive when one remembers that the VIX never dipped
BELOW 15.00 in 2002, 2003 or 2004. We would not rule out a happy ending, but we'd rather brace
ourselves for a tear-jerker. [Joel's Note: Will you be left cowering and cringing if our
fairytale market begins absorbing a few Quentin Tarantino
style plot twists? What happens if it turns into a Steven
King brand bloodbath? One thing is for sure, options
players will be relishing the rough ride. The more
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