Thursday, October 09, 2008

Enormous and ubiquitous.

If I talk about a market at all, I prefer to talk about its state or mood, rather than make price predictions. I don't hold myself out to have any better idea about the market than anyone else, necessarily. But sometimes, often during times of extremes, things become quite clear: like the VIX thesis presented a few posts ago. I still haven't gotten around to posting my crude oil thesis from this summer, but I may.

In my last post I said I thought equities were going into a trading range. Well, since the market sold off extremely hard today, I had to think about that thesis. It was in a trading range, of course, for most of yesterday and half of today. Then it broke like thin ice under a pogo stick.

I suppose the reason I think the 9-11 era lows fit is that they are crisis lows -- extremes. The low of the market of the week of Sept 17,2001 was 8235.81. Just a year and two weeks later, the week of Sep 30, 2002, the market hit a low of 7528.40. This is the range I mean, where I suspect we might hang for a while. This is an educated guess. Today's low was 8579.19 -- still a ways above the 9/17/01 low, but near enough. Also, glancing at a chart today, a trading range between 8000 and 10000 seems arguable, but contingent upon many things, not least of which is holding the 8000 area.

It was an interesting news day. One thing I noticed on Bloomberg was a story, early in the day, that quoted a bunch of experts on the VIX as saying that, once the short-selling ban was lifted, the VIX would come right down. These boys actually tried to make their readers believe that the short-sale ban was the cause of the VIX spike. This was such an inane premise -- exactly the reverse of reality -- that I felt it was my duty to the cause to truth to email the author and editor and tell them so. I said, among other things, exactly this:

And I think I can say with the utmost assurance that, had there been no short selling ban, the VIX would have explored much, much higher territory than it has in the pasty [sic] 20 years.

Of course, today there was no short selling ban, for the first time in 3 weeks. I sent the email at 10:53 am EST, when the Dow, at 9199, was 59 skinny points below the previous close. By the end of the day, the VIX made a 22 year high and the Dow was down 678.91 points. So much for the short selling ban causing VIX spikes.
In rereading the article looking for a representative quote, I see it is so full of educated ignorance that I could probably write a book just on it. But as the masthead says, "too many ideas, too little time..." Here's a quote that sums up the premise:

Since the Securities and Exchange Commission started the [short-selling ban] rule Sept. 19, volume on the New York Stock Exchange dropped 35 percent and the Chicago Board Options Exchange Volatility Index surged to 57.53 yesterday, its third straight record. Options on the VIX, as the volatility gauge is known, imply it will fall 44 percent in the next two weeks after the rule expired last night.

Can the VIX fall 44% in the next two weeks? Anything's possible. The article contains a liberal helping of quotes from "experts," some of whom allegedly manage deci-billions. Well, at least they allegedly did when they were interviewed this morning. But if they shorted the VIX like they were yapping about doing, well, I trust they're managing a bit less now. While I don't wish ill on anyone, I can't say that I don't like being proven so right so dramatically, and so fast. It was a ridiculous premise for an article and I really pity everyone involved.

Both Bloomberg and CNN continued being ridiculous by claiming, incorrectly, that the VIX had made all-time highs, later in the day. Check out CNN's graphic faux-pas:

I'm not going to waste my time with CNN, but I did email Bloomberg, after reading this headline:

VIX Options Index Advances to Record Above 60 on Credit Freeze

As pointed out in previous posts, in order to advance to a record, the VIX would have to register a reading greater than the high on October 20, 1987, and, indeed, for the entire CBOE VIX data set.

Bloomberg responded as follows:

hi charles,

bloomberg uses the new vix.


I think anyone would be confused by the nomenclature, myself included. In order to clarify, I revisited the CBOE site, and this is what I learned (white paper here):

The VIX was based upon OEX (S&P 100) options, from 1986 - 1993. Then, a new methodology was launched, based upon the SPX (S&P 500), with a different methodology that gives basically the same results. Then, in 2003, the original VIX was renamed the "VXO," while the new VIX was...still called the VIX.

Note: The data from Jan, 2004 - Aug 2007 has, in fact, an average difference (VXO-VIX) of -0.327 (2.4% of the average index value) and a standard deviation of that difference of 0.550. From July, 2008 - Oct 9, 2008, the average difference is 2.758 (9.0% of the average index value), with a standard deviation of 2.394 (CBOE seems to be missing VXO data from Aug 2007 - July 2008). The difference between the two, for determining trend and magnitude, is irrelevant. For this reason, it can be safely said that the all time high of the VIX, which is what it was called before it became the VXO, is, indeed that of October 20, 1987. While the then-current VIX high on that day was 172.79, the new methodology will undoubtedly result in a different nominal amount, but surely we can expect something relatively close in order to be considered a "record high."

Finally, the CBOE continues to publish current VXO data, and has a history available from 1986. So, determining an all-time-high of the fear index needn't be such a complicated issue. Enough about this.

We refer to our previous discussions about the VIX/VXO for some context, and, if you'll pardon our saying so, we said explicitly and repeatedly that, at 36, and then at 42, the VIX was not reflecting the gravity of the financial situation and must go higher, meaning equities must go lower. On Sept 17, the Dow closed at 10,609.66. We said, "Lower." On Oct 2, the Dow close at 10,482.44. We said, "Lower." Today? 8579.19 The VIX has been very useful in putting things in perspective.

We've also been saying, "Lower, ultimately." And we still are. No, we're not setting time frames and, no, we can't rule out bounces. In fact, we might be due for a biggie.

But this problem is not only enormous, it's ubiquitous.


[edit] we've just checked the Nikkei. In the two hours it's taken to write and edit this, the Nikkei has opened and dropped a whopping 13.25%. Enormous and ubiquitous, indeed.

Separately, IBM has just completed a $4 bn bond offering, priced to yield 387-400 bps over similarly dated US Treasuries. This is investment grade. Unless the world falls apart, someone's going to do really well on these.


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