Wednesday, January 18, 2012

Aqumin Volatility Newsletter 1/18/2012 - $AA, $VZ

Is the end finally in sight?

The 2nd half of 2011 saw tremendous changes in implied volatility as the market digested the fallout for possible European sovereign debt default. While that issue is not really solved, the Euro Banks have a reprieve by tapping the ECB facility to exchange their bonds for Euros in the short term. At last that will keep the system from freezing up which it was on course to do. Looking at the market in short term implied volatility is helpful in determining how successful the ECB’s actions are.

Take a look at the Aqumin Time Series Landscapes below. The Dow Jones Industrial Average (Dow) stocks are arranged by 10 Day Implied Volatility (IV10). The most recent day is on the right and just prior to the 2008 Financial Crisis is on the left. The 30 rows listed are the closing print of 10 Day Implied Volatility for each day which is denoted by the height and color. Note all of the red buildings just prior to the 8/19/2011 mark. That is showing IV10 closer to 15% (which is the dark red limit). Short term implied volatility did a bad job of predicting the crisis as the subsequent volatility spikes show.

1-18-2012 9-25-51 AM

1-18-2012 9-27-10 AM

If you look a little farther back on this Time Series Landscape you notice that as volatility comes down it tends to stay that way for a bit. The short term IV10 does a better job of predicting recent lulls than potential pops. That makes sense since paper sells shorter term options when there is no real trouble on the immediate horizon. Look at where I selected VZ and note that IV10 is starting to point way down again. There is some level now where the market is accepting the Euro situation. That is playing out and translates to lower short term volatilities. Looks like there might be a little room to run.

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