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Why You Shouldn’t Fear the Fear Gauge

Why You Shouldn’t Fear the Fear Gauge

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Excerpted from TheStreet.com – David Haitt, OptionMetrics CEO’s recent article:

The VIX can’t tell you when a rough ride is coming, but it may protect you when things get bumpy.

Over the past 20 years, the CBOE Volatility Index (VIX.X) has gone from an obscure market barometer relegated to peripheral space on a few hundred quote screens to a widely followed market indicator taking center stage in the financial news as a “fear gauge” during times of crisis.

While, by definition, the VIX is a measure of the market’s expectation of volatility over the next 30 days, constructed using implied volatilities from S&P 500 index options, it is popularly interpreted as a sentiment indicator, signaling investor fear or complacency. A lot of ink, air time and blog space is consumed posing and answering the question, “What is the VIX telling us about the market?”

It turns out the VIX is mostly telling us what we already know. But the degree to which this is the case may surprise even professional investors who have a good general sense of what the VIX does and does not capture.

This means that, although it purports to provide a measure of market expectation of short-term volatility, the VIX actually says more about present and past market performance than it does about future volatility. The “fear” being “gauged” is less about what might happen than it is about what already has happened.

At OptionMetrics, we provide historical option price data, tools and analytics to the financial services industry, and to scholars and researchers studying the markets. We performed a regression analysis (published in a new whitepaper) based on more than 20 years of daily closing VIX and SPX values from the OptionMetrics IvyDB US database, and it shows that almost all — 98.8% — of the daily variation in the VIX can be explained by current SPX returns and past VIX values.

To read the full original article published by TheStreet, click here.