Schaeffer's Trading Floor Blog

Notable Signs of Volatility Extremes

Volume swells on volatility ETNs

by 6/24/2013 7:17 AM
Stocks quoted in this article:

You probably don't need me to tell you that the selloff got pretty vicious last week, and some indicators flashed quite oversold. The CBOE Volatility Index (VIX) was one of them, though it hasn't gotten to the silly stage quite yet.

It peaked at 21.32 (so far), the highest reading since the last day of 2012. The high close was 20.49, almost precisely 20% above its 10-day simple moving average. That's overbought, but given the pretty scary drop in the markets, it wasn't what I'd call extreme.

And it's really not overbought when compared to 10-day realized volatility (RV) in the S&P 500 Index (SPX). That measure also peaked (so far) at 20.5 on Thursday, and now reads 18.8. The VIX normally carries about a four-point premium to a short-term RV reading (20-day RV is fine to look at too), but it's not unusual to see that premium evaporate or go to a discount in a volatility spike. Options pricing generally anticipates that volatility spikes will soon recede.

There are other signs of volatility extremes though. Our friend the iPath S&P 500 VIX Short-Term Futures ETN (VXX) saw all-time record volume on Thursday amidst a 10.5% spike that took it to levels not seen since February. What's more, VXX call volume hit an all-time record. On a contrary basis, it's bullish that the throngs are racing into the VXX and VXX calls, though I read less into an indicator that's consistent with market action. In other words, I'd get more bullish if the crowds were buying VXX and VXX calls into market strength.

Put/call ratios have gotten to extremes too, per the ISEE index. In ISEE lingo, it's actually a call/put ratio. I'm not a big fan of these sorts of numbers, though I do like the ISE methodology way better than the CBOE numbers. I'll let them explain:

The ISE Sentiment Index is a unique put/call value that only uses opening long customer transactions to calculate bullish/bearish market direction. Opening long transactions are thought to best represent market sentiment because investors often buy call and put options to express their actual market view of a particular stock. Market maker and firm trades, which are excluded, are not considered representative of true market sentiment due to their specialized nature. As such, the ISEE calculation method allows for a more accurate measure of true investor sentiment than traditional put/call ratios.

Anyways, they've calculated numbers for about 11 years now, and their All Securities call/put ratio hit a record low of 41 on Thursday. That's the equivalent of 2.5 on the CBOE put/call, which is enormous.

Again, it's consistent with the market move, but noteworthy that John Q. Public wants to own volatility ETNs, calls on volatility ETNs, and lots of plain old puts as the market is tanking.

So there are signs we've gotten a bit extreme here, but it feels likely we need one of those monster reversal days to truly end the market unrest.

Disclaimer: The views represented on this blog are those of the individual author only, and do not necessarily represent the views of Schaeffer's Investment Research.

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