Interest Rate Roundup

Tuesday, August 21, 2007

Noodling about volatility and market bottoms

Throughout this down move in the markets, we've heard repeated proclamations that "the worst is over" ... "the bottom is in" ... etc., etc. The latest assumption is that the Fed's discount rate cut will save the day (because rate cuts clearly worked so well in 2001, I suppose).
Anyway, I have also seen many options players cite the fact that volatility is spiking. They maintain that these spikes are bullish because they represent panic moves. But take a look at this chart of the CBOE OEX Volatility Index, or VXO. Every single volatility spike to date has been followed by a higher low -- and an even HIGHER spike thereafter. You saw a similar pattern in past crises, such as the Long-Term Capital Management meltdown in 1998. In fact, from July 20, 1998 through October of that year, I count 9 separate new "spike" highs in the VXO (including the ultimate intraday spike to 60.63 on 10/8/98).
At some point, we'll record a legitimate, major spike, followed by a legitimate reversal that leads to a lower low in volatility indices like the VXO. But until that happens, calling a bottom seems a bit dangerous to me.


Post a Comment

<< Home

Site Meter