Moving With the VIX

As we enter the third hour of trading, the broad indices are weakening from their opening highs as a weak economic report from the Richmond Federal Reserve questions retailers' holiday sales numbers, and concern regarding Iran surges. So far a big reversal in oil and energy prices is not boosting stocks. "Thin trading" is already is the becoming defining characteristic of the markets.

Options volume is extremely light thus far, though the industry is on pace to record its fourth consecutive year of 30% plus annual volume growth, and the put/call ratios remain at neutral 0.61 for equities and a 1.54 on index products. The VIX has inched up 2% to 11.75, which could be the beginning of a pickup in volatility. But with the gauge's increase only in its second day and still at historically low levels, it's too incipient to mean anything.

But a recent article in Barron's discussed a recent study by Credit Suisse analysts to test the predictive reliability of the VIX as a contrary indicator and its interesting conclusions. The twist was that the analysts converted the VIX into an oscillator by dividing its 186-day moving average (one year of trading sessions) by the current VIX reading. The VIX is currently some 20% below its 186-day average, which is near a two-year extreme.

The study's conclusion is that there is a greater risk of a big decline than a sharp rally from current levels. In the past I've mentioned using a basic rule of thumb when the VIX is 10% above or below its 10-day moving average: It tends to represent a relative overbought or oversold condition and signals a short-term turn in direction.

Admittedly, this rule has had mixed results, but having the frame of reference of the moving average is certainly better than simply looking at the absolute level and declaring the VIX "too high" or "too low."

In keeping with TSC's editorial policy, Steven Smith doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

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Steven Smith writes regularly for TheStreet.com. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback; click here to send him an email.

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