Tuesday, April 14, 2009

Time to prepare for volatile volatility?

With the S&P 500 rallying and the VIX Index on the verge of breaking technical support, which way is volatility like to go? Bill Luby at VIX and More says that the VIX could be regarded as either high or low, depending on the time frame.

How fat are the near-term tails?
There are indications that we could be in for a fat-tailed event. Tyler Durden at Zero Hedge speculates that the behavior of quant fund returns indicate that we could be in for another blow-up:

"Anyone who is doing anything sensible right now is either losing money or is out of the market entirely." These are the words of a quant trader, who is seeing something scary in the capital markets. Scary enough to merit a warning that we could be on the verge of another October 87, August 2007, or January 2008...

He pointed out that the runup was accomplished on low-volume, which may not be sustainable [empahsis mine]:

[T]he Volume Weighted Average Price of the SPY index indicates that the bulk of the upswing has been done through low volume buying on the margin and from overnight gaps in afterhours market trading. The VWAP of the SPY through yesterday indicated that the real price of the S&P 500 would be roughly 60 points lower, or about 782, if the low volume marginal transactions had been netted out.

Durden believes that the fast quant fund money is withdrawing to the sidelines. As many of these funds are liquidity providers, this suggests that the market could be setting up for a period of high volatility should any market participant try to come in to buy or sell in size. (Read his whole post here and follow-ups here and here.)

This is very intriguing analysis. If Durden is right, then is it time to buy volatility?

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