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Where's the Volatility?


This is typically the most volatile period of the year. Volatility is unexpectedly at low ebb... what does this mean?


Halloween is now over, and we are left with an eerie silence from the usual battle between bull and bear. This time of year is often sparked with tumultuous rallies and pullbacks, advances and corrections – i.e. volatile action. Instead, the market has etched out a dull but steady advance that has tightly stayed its course:

Last month I showed you this chart of the seasonality of historical volatility for the Dow Industrials from 1915 to 1999. Historical volatility is calculated by taking the standard deviation of daily prices on a year-by-year basis. Volatility may be thought of as the relative violence of price trends. It is not a measure of choppiness. This month I have added the historical volatility for the Dow so far this year (thin line.) As the chart shows, this year's volatility has uncharacteristically diminished into the 4th quarter (see circle in chart above.) My firm wondered just how often this has occurred in the past, and what significance, if any, is there to a low volatility market into year's end?

The above table shows the average historical volatility for all Octobers over the past 91 years. There have been 23 years where October has had a historical volatility below 10%. About 25% of the time we get such low volatility action (more than my firm had suspected, to be honest.) Therefore, 75% of Octobers have a historical volatility above 10%... and 29% of the time historical volatility soars above 20%. This year, 2006, October recorded the fifth lowest historical volatility in the past 92 years.

My firm was also curious to see if there was an implication to a high or low volatile October with regard to the November through December period. Here is what we found:

When October averages a historic volatility below 10%, the rest of the year tends to gain 4.15%. When October averages a historic volatility between 10% and 20%, the rest of the year tends to gain 2.61%. When October averages a historic volatility above 20%, the rest of the year tends to gain 0.76%. This last statement does have a couple of "outliers" in the data, namely 1931's year-end loss of 31.87% and 1937's loss of 11.26%. However, even if you remove those outliers from the data, the result for when October averages a historic volatility above 20% is still a relatively low 2.42%.

So, the low volatility is a good thing for now.

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