realmoney.com: fix your market-signal sights on the vix
realmoney.com: fix your market-signal sights on the vix
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realmoney.com: market analysis
fix your market-signal sights on the vix
by daniel dickerthestreet.com contributor
9/26/2007 2:30 pm edt
click here for more stories by daniel dicker
market analysis
normally, the vix would not be used as a directional indicator.when the vix has settled under 20, particularly under 15, the market has seen a steady, consistent uptrend.if the vix continues lower over the next few weeks, we could see fresh highs for all the major averages.
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one high-quality indicator for trying to fathom midterm trends in the stock market is the volatility index (vix). and right now, it's giving a clearly bullish signal on the market. i'll explain why it's a good indicator and why it's looking so positive now.
one of the most common games floor traders play, and one we often discussed during lunch hours or other breaks in the action, was the parallel motion (sometimes opposing motion) of seemingly unrelated markets. we'd look at oil vs. gold, the british pound against copper, and the stock market against the hot market du jour.
of course, this was no game. these markets weren't entirely unrelated, at least for the short term, and that was the trick. the game we were really playing was to see how fast we could find those connections and use them to advantage, and how long those connections would last.
the obvious commodity connections have already been made and have lost their usefulness for us: gold and oil now trade as if connected by a string. corn, too, has seen its price tied almost directly to energy through ethanol. let's look at something a little less examined.
normally, the vix would not be used as a directional indicator. its purpose is to gauge the spread of price action that one is likely to see in a day, week or month, on the basis of several of the chicago board options exchange's s&p 500 options. it is a prime ingredient in the modeling and pricing of options on equities.
while a number for volatility will imply option prices, what it shouldn't be able to do is give a bias on which options are more fairly priced. if a stock, for example, is trading for exactly $20 a share, the puts and calls for that $20 strike should trade around the same price; the measure of the stock's volatility gives us an indication of just what that price should be.
all along the ladder of options prices, the volatility that is applied to puts and calls also should be the same, but it often is not. when the implied volatility between puts and calls is unequal, we call that option skew. the bias toward either the put or the call helps give us insight into what market players are thinking about the stock's direction.
mathematical modeling is dry, humorless stuff. but when we can apply it to real-world traders, put the numbers together and finally get some insight into what they are thinking, we've got a bit of an edge.
i'm not going to delve any deeper into what volatility can indicate about specific stocks. realmoney has resident options genius steve smith to talk about specific option skews and other options strategies, and he does a tremendous job.
but let's take a quick look at the historical vix chart against the dow and try to interpret a kind of skew pattern i see.
click here for larger image.
source: cqg
the pattern is easy to spot and useful to apply: look at the vix chart and what happened in march, late july, mid-august and the beginning of september. each one of these spikes in the vix is mirrored by a fairly sizable downturn correction in the dow.
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related storiesmarket analysistime to book profits on treasuries9/11/2007 3:28 pm edtplus, tech stocks to buy and trade.market analysisthe u.s. engine will slow the world9/10/2007 3:41 pm edtmounting evidence suggests that the u.s. will hurt the global economy, not be saved by it.market analysisbig bets? big mistake in this market8/28/2007 3:04 pm edtwait for more extreme extremes or less volatility for better trades.
at the time of publication, dicker had no positions in any of the instruments discussed in this column, but positions can change at any time.dan dicker has been a floor trader at the new york mercantile exchange with more than 20 years' experience. he is a licensed commodities trade adviser. dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (doe, eia), cftc trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, bollinger bands, elliot wave theory, bar and tick charting and japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks.
dan also designed and supervised the introduction of the new nymex pjm electricity futures contract, launched in april 2003, which cleared more than 600,000 contracts last year alone. its launch has been the basis of nymex's resurgence in the clearing of power market contracts over the last three years.
dan dicker has appeared as an energy analyst since 2002 with all the major financial news networks. he has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on cnbc, bloomberg us and uk and cnnfn. dan is the author of many energy articles published in nymex and other trade journals.
dan obtained a bachelor of arts degrees from the state university of new york at stony brook in 1982.
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