Low implied volatility

There is a lot of disbelief expressed by many (and shared my me) about how low the implied volatility indices ( so called "fear gauges") are in the face of some of the heaviest selling we have seen in decades (as measured, by TRIN, TRINQ, TRIN5, TRIN10 and open-10 TRINs).

1) I think this might be partly related to the expiration of VIX options and futures, which expired EOD today. Since the VIX options were introduced, they proved a very effective way of hedging long positions. This is because everytime the market went down substantially, the VIX went up a lot more and the VIX calls rose accordingly. This meant that a 90% long poistion for instance could be hedged with only 1% of the portfolio in the right basket of VIX calls. I think the powers that be wizened up to this and have been deliberately holding down the VIX to eliminate/reduce its utility as a hedge.

2) A psychology that the bottom is just around the corner. So instead of buying plain old puts, put spreads are being bought. The increase in volatility is being viewed as an opportunity to sell some OTM options while hedging long positions using ITM options. The trouble is : this strategy does not work if the declines are larger than anticipated. One can see this effect in the relative skew of options on major indices. The implied volatility of OTM puts is lower than the IV of OTM calls. I am also seeing things in the OCC weekly options data that confirm this view.

There is a lot of disbelief expressed by many (and shared my me) about how low the implied volatility indices ( so called "fear gauges") are in the face of some of the heaviest selling we have seen in decades (as measured, by TRIN, TRINQ, TRIN5, TRIN10 and open-10 TRINs).

1) I think this might be partly related to the expiration of VIX options and futures, which expired EOD today. Since the VIX options were introduced, they proved a very effective way of hedging long positions. This is because everytime the market went down substantially, the VIX went up a lot more and the VIX calls rose accordingly. This meant that a 90% long poistion for instance could be hedged with only 1% of the portfolio in the right basket of VIX calls. I think the powers that be wizened up to this and have been deliberately holding down the VIX to eliminate/reduce its utility as a hedge.

2) A psychology that the bottom is just around the corner. So instead of buying plain old puts, put spreads are being bought. The increase in volatility is being viewed as an opportunity to sell some OTM options while hedging long positions using ITM options. The trouble is : this strategy does not work if the declines are larger than anticipated. One can see this effect in the relative skew of options on major indices. The implied volatility of OTM puts is lower than the IV of OTM calls. I am also seeing things in the OCC weekly options data that confirm this view.

Not sure how this adds, but the OEX Equity P/C ratio does not seem to reflect the drawdown levels of fear in Qs for instance. It has been showing less and less fear as drawdown levels increase, relative to prior proportional fear levels. Watching the SOP line and ITM profile, I am finding it hard to believe so many call writers will get blasted in three days, although it is also interesting how they eliminated programming trading curbs just about at the top of the market since "they had no noticeable impact on stemming volatility." Not only that, but the COT indicators have been fubar as well. I don't know, but it seems that as more and more of the little folks are picking up on sentiment indicators, the more they find ways to disguise motives around these.

Edited by watchthemarkets, 15 January 2008 - 07:20 PM.

There is a lot of disbelief expressed by many (and shared my me) about how low the implied volatility indices ( so called "fear gauges") are in the face of some of the heaviest selling we have seen in decades (as measured, by TRIN, TRINQ, TRIN5, TRIN10 and open-10 TRINs).

1) I think this might be partly related to the expiration of VIX options and futures, which expired EOD today. Since the VIX options were introduced, they proved a very effective way of hedging long positions. This is because everytime the market went down substantially, the VIX went up a lot more and the VIX calls rose accordingly. This meant that a 90% long poistion for instance could be hedged with only 1% of the portfolio in the right basket of VIX calls. I think the powers that be wizened up to this and have been deliberately holding down the VIX to eliminate/reduce its utility as a hedge.

2) A psychology that the bottom is just around the corner. So instead of buying plain old puts, put spreads are being bought. The increase in volatility is being viewed as an opportunity to sell some OTM options while hedging long positions using ITM options. The trouble is : this strategy does not work if the declines are larger than anticipated. One can see this effect in the relative skew of options on major indices. The implied volatility of OTM puts is lower than the IV of OTM calls. I am also seeing things in the OCC weekly options data that confirm this view.

Not sure how this adds, but the OEX Equity P/C ratio does not seem to reflect the drawdown levels of fear in Qs for instance. It has been showing less and less fear as drawdown levels increase, relative to prior proportional fear levels. Watching the SOP line and ITM profile, I am finding it hard to believe so many call writers will get blasted in three days, although it is also interesting how they eliminated programming trading curbs just about at the top of the market since "they had no noticeable impact on stemming volatility." Not only that, but the COT indicators have been fubar as well. I don't know, but it seems that as more and more of the little folks are picking up on sentiment indicators, the more they find ways to disguise motives around these.

meant to say "option writers" will get blasted in 3 days (both sides). They sure don't give much time to edit posts on this forum, do they ?