  |
|
The Sleuth
With the large gyrations we’ve been witnessing recently in the major stock indexes, there has been a lot of talk in the financial media about “volatility” becoming more a part of the everyday market. Although it pains me to say it, the purveyors of business news, gossip, and opinions are right this time. I guess that just validates the “broken clock” and “blind squirrel” theories. The stock market has, in fact, been subject to a greater degree of volatility in recent weeks. But how do we measure that volatility, and what are the financial pundits actually referring to? ************************************** The “10-Year” Energy Stock In a vial, it's as clear as water... It has no smell... Yet it packs enough punch to fuel every single truck, car and diesel engine train in America for the next 811 years. The company that makes it could very well be the best energy stock for you to own, now and for the next 10 years. Read on to find out more... ************************************** It’s a metric constructed by the Chicago Board of Options Exchange (CBOE) known as the Volatility Index -- or VIX for short. Just what is the VIX, and what information can be gleaned from its readings? Let’s begin by considering what the VIX measures and how it’s constructed. Once you understand that, you will have a better idea of why you’ve been hearing so much talk about this measurement and the implications you can draw from it. Here is an excerpt from a report on the VIX found on the CBOE website: “VIX continues to provide a minute-by-minute snapshot of expected stock market volatility over the next 30 calendar days. This volatility is still calculated in real-time from stock index option prices and is continuously disseminated throughout each trading day.” Notice the use of the word “continues” in the first sentence. That’s because the report I just quoted from was prepared in 2003 by the CBOE to introduce a change in the methodology behind the VIX. I’ll get to that in a minute. The VIX was originally conceived in 1993 to provide traders and investors with an up-to-the-minute gauge of market volatility. The VIX measures the amount of volatility contained -- at any moment in time -- in option premiums. In its original form, the VIX was constructed by using a weighted average of the implied volatility of the at-the-money and near-the-money options on the S&P 100 index. The composition of the VIX was changed in 2003. At that time, the CBOE created a “new” VIX by making two changes to the original version. First, options on the S&P 500 index were substituted for those on the S&P 100. The CBOE decided that the S&P 500 -- a widely followed average commonly used by mutual funds as a benchmark to judge their performance results -- was more representative of “the market” than the S&P 100. ************************************** An Expert’s Favorite Pick This company’s product is already being used by some of the largest transportation outfits in the world. Airlines, trucking fleets, bus companies and car rental businesses are suffering huge losses due to rising gas prices, and this product is rapidly becoming the No. 1 way to save on operating costs. Find out more about the one stock that topped Chris Mayer’s list of more than 8,000 possible picks... ************************************** The second change made by the CBOE was to increase the amount of options used in the calculation of the weighted average. It was thought that by expanding the number of options used to calculate the weighted average, the VIX in its newer form would provide a more accurate representation of the level of implied volatility currently existing among option premiums in the market. All options used in the VIX calculation are either in the front month -- i.e. the nearest month to expiration -- or the second month. The reason the CBOE limits options to the two nearest months is because it is their goal for the VIX to estimate the implied volatility of what an at-the-money option on the S&P 500 would contain with 30 days left until expiration. The VIX is quoted in terms of a number between 0 and 100 -- and normally trades at the far lower end of that range. For instance, as of the close of trading on Monday, June 19 the VIX was at 17.83. That number represents the anticipated percentage movement -- both up and down -- in the S&P 500 index over the next 30 days. So, for example a VIX reading of 24 would mean that -- based upon the implied volatility in the options on the S&P 500 index in the front and the second months -- the index is expected to move within a range of 2% (the 24 VIX reading divided by 12 months) over the next 30 days. So, why is the VIX important? For one, it provides you with a reasonable projection of the expected range within which the S&P 500 is likely to trade within the next month. To use the current environment as an example, the S&P 500 closed on June 19 at 1240.14. The June 19 closing VIX reading of 17.83 suggests that options traders and investors anticipate that between now and July 19, the S&P 500 is likely to trade roughly within 1.49% range (17.83 divided by 12) of 1240.14 -- or between 1221.71 and 1258.57. Now, that doesn’t mean the S&P 500 will actually trade within that range. Keep in mind that the VIX changes on a minute-by-minute basis, according to the ongoing changes in the implied volatility in the S&P 500’s nearest two months’ option premiums. Therefore, the VIX -- and hence the projection of the S&P 500’s trading range for the next month -- is being constantly revised. Nevertheless, that projection -- as gleaned from the latest VIX reading -- is an accurate reflection of the attitude of traders and investors about current market conditions. And that reflection of traders and investors’ attitudes is the heart of the VIX’s value. When you can correctly gauge market participants’ attitudes -- and then use that information to anticipate likely future price action -- you have acquired an additional edge in your efforts to make money in stocks. In my next Technical Tuesday column, I’ll talk about the meaning of specific VIX readings. More importantly, I’ll discuss how you can use that knowledge to your advantage. Trade well, Mark Bail
Read all about this pick, and a second company that gives you a six percent dividend PLUS a chance to double or triple your capital... |
|
|
Mark Bail has spent several years studying the financial market as well as running several options, equities, and mutual fund newsletters... <click here for full bio> |
|
