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Option Action Lacks Conviction

Another important option gauge is the CBOE Market Volatility Index, or VIX, which measures the implied volatility of the S&P 500 options. It's important to remember that the VIX is a measure of the implied volatility of the S&P 500's 30-day options. The fact that the VIX hit a 10-year low of 10.33 in late July was more a reflection of the index having been bound within a narrow trading range than a sign of complacency.

Indeed, during August, when the S&P was trending down, the VIX was the mirror image, staging a monthlong climb that hit a high of 13.96, and culminating on Aug. 29, when hurricane Katrina hit land and the market marked a bottom.

The S&P has since climbed some 2.7% and the VIX has declined 10% to 12.56. Usually a surge in volume and a decline in the VIX would be a sign of optimism or bullishness. But right now it seems that investors are taking advantage of the low volatility to buy cheap options to reduce risk. This can take the form of either purchasing put protection or buying calls to replace long positions, both of which are forms of risk reduction. While this may represent a healthy level of prudence and caution, it is not the type of activity that propels stocks to new highs. Until volume turns back up, the upside will be limited.
Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. 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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