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Does VIX Suggest End to Equity Price Run-Ups?

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A look at the volume of contracts traded -- and who's doing the trading.

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One average of the volume of contracts traded in VIX futures recently exceeded the level observed during the financial crisis of 2008, indicating that sophisticated traders and investors may be preparing for an end to the recent run-up in equity prices.

The chart below shows the volume of trading in VIX futures (VX) since January 2008, along with a 20-day simple moving average of that volume. As evident there, the average volume in recent weeks is greater than at any time in the past two years. Increased VIX futures trading volumes are to be expected amidst market declines, given the increased activity observed in late November 2007 and October 2008. What's remarkable about the recent surge in volume is that it's coincided with a bull market in which declines are brief and mild.


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According to data supplied by the CBOE, the average daily volume traded in VIX futures for October 2009 has been just shy of 7,000 contracts. The average for October 2008 was about 5,200 contracts, or just above 6,000 if we include the 25,000 contracts traded on September 29. The contract size of (and limited access to) VIX futures has kept them from being widely adopted among retail and individual traders, so it seems fair to suppose that activity in this product represents the opinions of "smart money" traders, or is at least not merely the result of this product becoming more popular.

However, it's worth considering who exactly is likely to be taking positions in VIX futures: derivatives desks with short volatility exposure in other assets, liquidity providers hedging VIX options sold to small traders (see the chart below), and large equity funds looking for portfolio insurance are all possible candidates. Increased trading by those sorts of actors can just as easily be interpreted as neutral or guardedly bullish, instead of ominous.


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As the S&P 500 tests its 50-day moving average for the fourth time since March, it will be interesting to see how trading in the VIX complex responds to any sustained weakness in equity prices. The presence of traders making bets on increasing implied volatility isn't, by itself, of particular interest. But it should be informative to see how those traders respond in the event that long volatility positions begin to play out favorably.



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