Buzz and Banter
Tony makes a very good point on VIX and I would like to expand upon it. VIX is calculated by taking various near money OEX options and weighting their implied volatilities to come up with one number. This indicates that at best it gives us an estimate of volatility and at worst is misleading.
First, the OEX is not all that popular anymore for hedging purposes; the SPX is preferred by most managers. The volume is more retail than institutional, which may or may not be a better indicator of sentiment. Second, the OEX is a subset of the SPX: it has a heavier weighting in the largest capitalization names and does not even discount what is going on in 400 of the smaller companies. Third and most important, it is an index option. Index option prices move more based on the correlation of names than on the volatility of names. For example, let's pretend that the OEX is equally made up of only two names: General Electric(GE:NYSE) and Microsoft(MSFT:NASD). If the volatility of both names goes up, but the correlation between the two goes down (GE is up a lot and MSFT is down alot), the volatility of the index and therefore its option prices may actually go down!
Even though I comment from time to time on the VIX, for these reasons I rarely use it. I am much more interested in the options of the components, the individual stocks. In general I can tell you that the implied volatilities of the financial sector stocks (except for Fannie Mae(FNM:NYSE)) are as low as I have seen them in a long time. Some of the technology names like International Business Machines(IBM:NYSE) are very low also. The main reason VIX has not dropped more is because the correlation between stocks is still higher than it was in the 80's and 90's. I think that is to be expected given the higher bond volatility. So in general I would say that option prices are pretty low, even against the levels of the 80's and 90's. I will leave it to Tony to interpret that.
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