The VIX: Could the “Fear Gauge” Call a Market Bottom?

Posted by: Ben Levisohn on October 8, 2008

Since the Dow started its precipitous drop from its record high of 14,000 one year ago, options traders and savvy investors have been waiting for the S&P Volatility Index, or VIX, to take notice. The VIX is often referred to as the fear index, but no matter what happened — the popping of the housing bubble, the collapse of Bear Stearns, the implosion of the monoline insurers — it stubbornly refused to trade above 35, a remarkable sign of complacency (the VIX traded as high as 150 in 1987). Even the government takeover of Fannie Mae and Freddie Mac failed to move the needle.

That all changed on September 17, when Lehman Brothers came under intense pressure leading up to its bankruptcy filing and the VIX took up home in the 30s. And when Congress failed to pass a bailout bill after the close on September 26, the market collapsed and the VIX spiked to 46.72. Today, it trades in the 50s. (See Chart) Now, it appears investor complacency has gone the way of Lehman.

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But contrarians everywhere see the rise in fear as a possible buying opportunity. The Dow has dropped 5,000 points, they say, and though the market may still drop another 1,000 points or more the VIX is one sign confirming that we may be oversold. Of course, the problem with being oversold as that you can always get more oversold, but Barry Ritholtz of Ritholtz Capital Partners believes the VIX is signaling a trading low, if not a permanent one. “It doesn’t mean you run out and go crazy but this is not the time to panic,” Ritholtz says. “The time to panic was a year ago.”

Reader Comments

Warren Shushi

October 9, 2008 2:35 PM

I have no problem with contrarians using any signal as a buying moment. However, I hope you pay more attention to the SPDR option spread. The widening of the spread may artificially increase the VIX value. As a result, using VIX is not as realiable as it was before.

Mark

October 11, 2008 11:42 PM

Yes, the market is still in extreme panic condition (VIX index to a new high) + rising foreclosures (107 500 homes lost in September. Link: http://www.marketwatch.com/news/story/us-foreclosures-index-... + rising bankruptcies ( up 93% VS August 2007. Link: http://www.inlandnewstoday.com/story.php?s=4199).

but I think it's too early to call 8000 is a bottom... I will say the market will drop more to 2000 before it can find a bottom.

Similary in Japan, bankruptcies (up 34% vs last year. Link: http://www.reuters.com/article/rbssFinancialServicesAndRealE...

foreclosures soared to a record level as well...

I will say there will be more financial, insurance institutions to collapse (already 2 more banks failed on Friday) in months ahead. The worst has yet to come... who's going to pay the insured credit default swaps? In Lehman Brothers' case, the payouts is expected to be in between 400 to 600 billion. Link: http://www.nytimes.com/2008/10/11/business/11credit.html?em

More banks, insured companies going under for sure in the months ahead... remember, CDS is not a regulated market and its size is more than 55 trillion... 5 times more than the size of US GDP.

It's probably now too late to rescue the banks or create the market for CDS... given its size, number of clients involved, etc.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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