Investors Aren't Fearful

Saturday, September 06, 2008

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2 comments:

Mark Porter said...

Do you know if the volatility index considers the number of options or just the cost of options? I am thinking that if hedge funds are liquidating, they would naturally participate less in options trading due to lack of resources.

Name: Brandon Rowley said...

As far as I understand, it's just the cost, not the quantity. I'm assuming that you're thinking that the VIX is lower than it would be if hedge funds were more active. That's a more complicated argument than I can precisely answer but I have a couple thoughts. I could be completely wrong with these ideas but I'll throw them out there anyway.

Redemptions at hedge funds that sold stocks this week probably don't have much to do with equity options. Options traders generally trade volatility, not actual increases/decreases in stock prices. So, traders look to buy when volatility expectations are low and sell when volatility expectations are high. I wouldn't think that most sophisticated hedge funds would've been simply taking call or put positions on the index just betting direction. The success or failure of these strategies has a lot less to do with general market direction and more to do with volatility expectations.

I guess I'm saying that I'm not sure options trading volume correlates to poor market performance. I would also think that less activity, less liquidity, would push up spreads and, therefore, implied volatilities. If that is true, the VIX should be higher, not lower, with less volume.

All in all, I really don't know, just some thoughts.

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