March 17, 2010 | 1 Comment
VIX Doesn’t Work as Signal for U.S. Stock Returns, Birinyi Says
March 17 (Bloomberg) — Investors looking for clues about the U.S. stock market should probably ignore the Chicago Board Options Exchange Volatility Index, according to a study of the VIX by Birinyi Associates Inc.
Speculation that equity returns will be positive after the volatility gauge decreases and negative when it climbs has little basis in fact, Birinyi said. "The VIX is alleged to be an indicative indicator and has become a staple of analysts and journalists alike," Laszlo Birinyi and analyst Kevin Pleines wrote in a report to clients.
The following is a table of the S&P 500's average gain or loss during periods after implied volatility climbed above or fell below the 50-day average: (since September 2003)
1 Month 2 Months 3 Months 6 Months
VIX 20% Below 0.09% -0.49% 3.33% 5.84%
VIX 20% Above 1.25% 0.50% 0.95% -4.51%
Source: Birinyi Associates
Larry Williams writes:
As I have always postulated, the VIX is just the Dow/S&P upside down. It's hard to predict A with A.
Jason Goepfert comments:
I'm not a VIX fanboy by any means, but that article was ridiculous. It only looked at returns since September 2003. And it only tested a strategy of crossing 20% above or below the 50-day average. Why 20%? Why the 50-day average? Why just since September 2003? Did they test anything else? Or is that the one they found that supports their (so far very correct) bullish view?
The ridiculous part is taking such a weak study and then proclaiming "the VIX doesn't work."
Allen Gillespie adds:
He doesn't have enough bins — bins of 5 show something different.
Kim Zussman writes:
- Volatility was extinguished by fiat liquidity
- The only double-dippers left are Jibao, Roubini, and Michael Moore
- Nothing to fear above moving averages
Marlowe Cassetti responds:
I have always doubted the assertion that VIX is a measure of market fear and greed. Years ago I read Whaley's academic paper and I was not satisfied with the author's fear/greed connection. To me VIX is simply the volatility number you plug in to make the Black-Scholes option equation work.
Bud Conrad answers:
My detailed review of VIX concluded that the VIX followed stocks (inversely) a day later. It was not predictive. Longer term charts seemed to indicate opposite movements, but the data could not be used as expected.
I personally believe that the Uptick Rule should be reinstated or large money pools will be created to drive stock prices down on selected companies.
Alex Forshaw replies:
Why do you find it ok that speculators drive prices up, but not down?
Sam Humbert counters:
I will show you an article, the subject of which was how CNBC was unknowingly complicit in the fall of Bear Stearns. You might find it informative.
Jason Goepfert says:
So one of the largest investment banks and securities traders in the nation was taken down because traders didn't have to wait for an uptick to sell short? It didn't have anything to do with the fact that they had bitten off way more than they could chew and should have been deleted as on ongoing concern? That seems a little fanciful to me.
There were hundreds of stocks that were taken off the uptick rule for a couple of years prior to July 2007, in a trial balloon run by the regs. They studied the trading patterns on those stocks extensively compared to those that were still subject to the rule, and found little difference in trading patterns. The rule was not lifted by whim.
With penny pricing, it doesn't take much to get an uptick in a stock. If a large fund(s) really wanted to take down a company, the uptick rule makes no difference. They would just buy a bunch of shares, get the stock on an uptick, then short the hell out of it again. Or buy puts, or any of the other derivatives they have available.
The stock would go to zero whether the rule was in place or not. See Enron et al.
Blaming the uptick rule is lazy.
Sam Humbert comes back again:
Marty Whitman of 3rd Ave Value Fund has issued a statement in effect also blaming the elimination of the Uptick Rule as one of the factors that the bear raid on Bear Stearns was successful.
I agree with Marty Whitman.
As to driving prices up versus driving them down, there is a difference. Quickly falling stock prices can cause a panic which could cause money withdrawals from some stocks such as brokerage and banking firms, which in turn can cause bankruptcies and job losses.
Dylan Distasio recalls:
The fact of the matter is that uptick rule was easily avoided prior to its elimination through the use of married puts aka "bullets." When I traded intraday (before the SEC essentially eliminated this use of them in 2003), we used to use them on a daily basis.
Gibbons Burke also disagrees with the uptick rule:
If all the artificial barriers [such as the uptick rule] are removed the knowledge that stocks are more susceptible to bear raids will temper the irrational exuberance that lofts stock prices far beyond their real value, which causes them to correct just as dramatically.
Wall Street is institutionally bullish, and it extends even to the press covering the street, so support for the uptick rule is understandable, if not reasonable and rational. For example, I know from personal experience that Dow Jones requires all employees to sign agreements when they're hired on to never ever sell short, or be effectively short with options. No one on the entire staff of the Wall Street Journal has any interest in or ability to benefit from stocks going down. It renders the Journal a tout.
Mr. Albert has the day trader's perspective:
1) the nasdaq 100 had no uptick rule for quite a while before the general repeal
2) S stocks on the Nasdaq, certainly the most subject to bear raids as they have much shakier financials and tend to be story stocks, never had an uptick rule since I began trading in 1996
3) none of the SHO pilot stocks was more volatile than the comparable non Pilot stocks (in need to find the acedemic reference but it is there). IMO the specialist system (not the uptick rule) was a stabilizing force in the markets so now we have more vol
James Lackey has seen it all before:
All you get from more rule making, margins, uptick or program rules etc is bigger gaps at opens and closes. Restrict intra day moves and the energy must be transferred somewhere else.
Steve Leslie updates:
Yesterday the SEC announced that they were selectively reinstating the uptick rule for Fannie Mae and Freddie Mac. Why just those two stocks? I have no idea what this accomplishes other than a symbolic gesture. Could you imagine commodities having a limit up or limit down rule for just corn or beans? Couldn't they just raise the margin requirements for borrowing stocks ? As usual governments are late to the party. Back in 1987 the Government began looking at computerized trading and the use of collars. Of course this was after Oct 19th debacle. Look at Hurricane Katrina and see the government in action during a crisis situation. And yet there are still those who try to tell the public that the government is the solution to its problems. The bankrupt LA Times had a front page article arguing for government intervention in the financial markets, especially subprime. Politicians' cliches include "we can't drill ourselves out of the oil crisis and it is the speculator who is the cause of the problem." They are the ones who need to be ratted out and summarily chastised and shot. And then they use trite phrases like "We need to send a message to these oil companies and the speculator that they are going to be reined in." And then they hold a hearing in front of cameras, ask mindless, rehearsed questions formulated by their aides and attempt to project themselves as informed. Yet they expose themselves as what they truly are. Robots, empty suits whose prime objective in life is to get re-elected and retain their cushy phoney baloney jobs. And Nero fiddled while Rome burned. I think I will go outside and get a breath of fresh air.
Investors are often perplexed by the lack of warning of market tops and bottoms, until after the fact. There is no alarm bell tolling. However, there are warning signs at the tops usually based upon enthusiasm, and at the bottom signs based on despair. Didn't Mutual Fund Magazine close its shutters at the end of the last bear market, ringing the bell near the bottom? So now we have a new FOX Business Channel to start broadcasting this year.
Is this a warning bell that the market is flirting with the top?
Victor Niederhoffer writes:
This is all very well and good except that there are approximately 1 billion qualitative events like starting a new business channel that come within a month of all market tops, bottoms, and continuations. It is impossible to differentiate the cause, effect, or any other factor related to the seemingly and for the large part random movements from drift.
From Jason Goepfert:
My local Barnes & Noble is relatively small and its business magazine section is sparse, Forbes, Fortune, BusinessWeek and not much else.
Last year, they started carrying Active Trader, which I found at the back of the top rack. If I weren't 6'6", I never would have seen it.
This weekend, on the second shelf, I was taken aback when I saw the following magazines all prominently displayed: Active Trader; Equities Magazine; Technical Analysis of Stocks & Commodities; Traders Press; Trader Monthly; and Bloomberg Magazine
Jim Sogi writes:
My daughter called last week and said, "Dad, I want to buy some stocks, now." I said, " Wait till they go down a bit." She said, "You always say that." I told her that, as with the rest of the public, with recent all time highs, the urge to buy stocks at high levels is typical but often wrong. It is better to buy stocks when they are down so you aren't down a couple percent as soon as you buy. She looks at her stocks about once a quarter.
From Stefan Jovanovich:
The actual use of canaries in coalmines fails to provide the historical lesson that the metaphor promises. Mining for "sea" coal (named because the earliest pits were at the coastal towns like Newcastle in what is now the United Kingdom) began in the 1400s. Canaries were first used in British coal mines in 1911. As part of the political alliance between the Liberals and the new Labor Party, parliament adopted regulations requiring that two canaries be placed in every mine. That, of course, required that someone be assigned the job of canary keeper.
The requirement for canaries was finally abolished in 1986. There is no evidence that the canaries served any useful purpose; the scientific justification was so weak that they were first described as being uniquely qualified to detect carbon monoxide. When that proved not to be the case, they were rationalized as being peculiarly sensitive to methane. The canary in the coalmine is probably better compared to the caboose on the rail train, a "safety" requirement that provided a comparatively soft berth for the man assigned to the useless activity.
It is sometimes helpful to understand the infrastructure of Wall Street and LaSalle Street. Consider what must go through the minds of margin clerks and risk managers and heads of firms when the market can spike up by 20+ S&P points in one minute on light volume. That’s a $5000 per contract move in the big S&P, and any margin account that couldn’t stand that and be in good shape at the time, would cause great trepidation. Consider also, the others hanging onto their shorts. “Dear, don’t give me that ‘d#mned broker’ stuff any more. If it had stayed up there for one more minute, you could have gotten a call and we would have had to cancel the vacation and send Joe to State College. Promise me that you won’t put us in that position again.” You can try also to put yourself in the minds of those who were short and saw themselves on their knees or backs, and were repreived when Clever Hanses knocked the price back from 1398 to 1376. “My goodness, tell me again how close to death I was before they defilibrated me? I promise I’ll give up smoking now.”
Jason Goepfert replies:
While difficult, I would suggest that everyone try to find a way to observe the inner workings of a brokerage firm margin department.
I managed such in the late 90s for the discount side of a large bank. When traders are heavily margined and facing a call, the vast majority do not use objective analysis, or even limited intelligence, in making their decisions. They use raw emotion.
And what most don’t realize is that those on the other end of the phone are subject to the same. There is an extraordinary amount of pressure on the margin clerks and managers, and when faced with settlement deadlines, their pulse quickens as well - it is not all about rules and procedure.
One nasty day in particular a large client dipped below his equity requirement and was up for a forced sell out. None of my margin clerks could reach him - it turns out he was in the championship of the World Series of Poker at the time.
At the 11th hour, he called frantically insisting that he had the funds available in a bank safe, denominated in poker chips. Given the amount and the client, the decision of whether to sell him out went all the way up to just under the CEO. He said sell, so we did, adding not a little pressure to the current market decline.
The client promptly sued us. And won. A lot.
While I believe the impact of margin selling on overall market performance is greatly exaggerated most of the time, in times of duress it is not as wave after wave of sell orders emanate from these shops, often in close proximity as the guidelines from firm to firm are fairly close.
Dr. Kim Zussman adds:
Adaptive Optics is a technology used by astronomers to counteract atmospheric blurring effects which degrade images for earth-based telescopes.
One method uses a laser to project to the upper atmosphere, creating an “artificial star”. Images of this star, which contain information about how light waveforms are distorted as they fall through the local atmosphere, is used to modulate a flexible mirror which corrects the wavefront and greatly sharpens actual star images.
Might “fat finger” events or other strange/large trades represent a form of artificial star designed to perturb markets for the purpose of sharpening the real picture? If so, who are these astronomers and can we benefit with our own specs?
Vincent Andres responds:
Another image which comes to my mind is that such events may be a voluntary stress applied to the market in order to visualize where may be germs of possible fracture lines.
Not obvious to exploit when seeing only the input signal’s echo and without precise dating.
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