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Schaeffer's Media Outtakes: An Elevated VIX Points to Continued Gains

Why the Rising CBOE Market Volatility Index (VIX) Signals Less Complacency

by 6/18/2007 2:28:36 PM
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In our Schaeffer's Media Outtakes series, Bernie Schaeffer dissects the news, using contrarian analysis to provide a unique take on the market.

"As stocks return to record levels, the smooth sailing that characterized stock trading at the end of 2006 and early 2007 isn't likely to return, these traders are signaling by demanding considerably more for options on the Standard & Poor's 500-stock index than they did earlier this year. That worry has in turn appeared in readings of the Chicago Board Options Exchange volatility index, or VIX ... The move has shocked traders into realizing the risks that stocks face, and they haven't stopped worrying about them since."
----(The Wall Street Journal – "Options Signal Wake-Up Call On Stock Risk" – 6/18/07)

"The stock market's wild swings in recent weeks -- a new record one day and a big drop the next -- have some investors looking at how to protect themselves against unexpected losses. The notion was far from their thoughts just a few weeks ago, when stocks seemed to have nowhere to go but up ... Historically, many bullish Wall Street pros have shunned hedging, viewing it mostly as a way to leave money on the table if stocks rally. 'I don't know why people are so resistant to the idea of buying downside protection,' Lehman Brothers portfolio manager Aaron Gurwitz told reporters recently. 'If you buy fire insurance for your house, you're not disappointed at the end of the year if your house doesn't burn down.' Mr. Gurwitz has been keeping a close eye lately on the Chicago Board Options Exchange's Volatility Index, which tracks options prices as a gauge of how much market turbulence investors expect in the months ahead. The index, known as the VIX, is up nearly 21% this year, at 13.94, signaling that investors have increasingly been buying options as a safeguard against losses in their stock holdings."
----(The Wall Street Journal – "How to Hedge Wisely" – 6/16/07)

Schaffer's addendum: The ratcheting up of the low end of the CBOE Market Volatility Index (VIX: View sentiment for VIXsentiment, chart, options) range from single digits to the floor in the 12-12.50 zone that has prevailed since March is, in my opinion, a major positive for the sustainability of this bull market.

The fact that premium sellers are demanding more for assuming risk is a direct refutation of the "complacency" argument those looking to call a top are so fond of trotting out. And to the extent there is less premium selling activity, the "speed bumps" that are created at strikes with large open interest that can often slow rallies to a crawl are mitigated.

The S&P 500 Index (SPX: View sentiment for SPXsentiment, chart, options)

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