Elliot Turner of T3Live.com
With the market chopping around just below move highs and an abundance of divergences popping up across the board, I thought it would be an interesting time to take a look at volatility. Intraday traders prosper in volatile markets and tend to struggle in an inconsistent, low vol environment. Whereas over the past two years stocks predominantly moved in unison with the broader markets, right now trading is particularly stock specific. That could have a lot to do with realized and expected volatility. At Vix and More, they raised an interesting point:
One month ago the VIX closed at a 2009 record low of 20.69, so it should not be a big surprise that realized volatility over the course of the past month has been higher than predicted by the VIX. What I find interesting about this development is that last week was the first time since February 27th (exactly one week before the market bottomed) that 21 day realized volatility turned out to be higher than the level of volatility predicted by the VIX.
That being said, let’s look at the charts. The first chart here is a monthly chart of the VIX, covering the past decade of stock market activity.
As you can see, the bull market following the tech bubble recovery saw volatility settle in an incredibly tight range. Implied volatility over that time saw cyclical volatility hover near its lowest levels since the inception of the VIX index. However, 2008 brought about an unprecedented rise in volatility. Neither the blowup of Long Term Capital, nor the implosion of the tech bubble brought the VIX to such soaring heights. The turbulent macroeconomic environment led to rampant volatility at a sustained high level which ultimately subsided slowly as the market retraced nearly 50% of the down move. Since the VIX/volatility tend to be cyclical in nature, it is reasonable to expect a period of heightened volatility following the 2003-2007 lull. The question begs as to how long that volatility will last–is two years or are we in for more?
Here we are today, with the VIX at its lowest level since the pre-Lehman days, yet well off of those 2003-2007 bull market lows. Let’s now take a look at a daily chart.
We saw a significant move in volatility late in October as the market dropped, yet as the market melted to new highs during this present month, the VIX has not made new lows–could this be the first higher low? With realized volatility outpacing implied volatility, we have yet another important market inflection point to focus on, along with the confluence of the Lehman gap resistance, the 50% retracement level of the S&P down move and the downward trendline intact off of the October 2007 and May 2008 highs. It seems as though we might be on the brink of another spike in volatility.
Until that happens, intraday traders must remain cautious in pursuing trades, exercise increased patience and discipline, and implement a stock specific approach to trading. Once the market resolves this key inflection point in price and volatility, the choppiness should subside and intratrading shall recommence. For longer-term traders, especially those with a net long exposure, it could be an interesting time to explore a long vol position as a mechanism to hedge your portfolio.
